Bank of Japan sticks to playbook to rein in sharp declines in yields

TOKYO — The Bank of Japan (BoJ) will stick to its playbook of minor tweaks and verbal warnings to rein in sharp falls in longterm interest rates, sources say, raising questions about its ability to control the yield curve while managing market expectations.

The key 10-year Japanese government bond (JGB) yield spiked on Tuesday after a poorly received auction, a sign markets were finally paying heed to BoJ Governor Haruhiko Kuroda’s recent comments warning against excessive falls in super-long yields.

In the last month the BoJ has repeatedly signaled its displeasure over what it saw as excessive declines in super-long yields and a flattening yield curve.

It has also reduced its bond purchasing plans for most maturities and signaled it could forgo operations to buy bonds with a maturity of over 25 years.

Such efforts have given rise to market views the BoJ is serious about steepening the yield curve, even if such attempts risk being interpreted as a withdrawal of monetary stimulus.

“Market players realized the BoJ had a strong desire to prevent the yield curve from flattening,” said Mari Iwashita, chief market economist at Daiwa Securities.

“The BoJ is using verbal signals skillfully and controlling the yield curve fairly well these days,” she said.

Japanese finance and central bank officials took Tuesday’s price action in stride, describing it as a one-off move rather than the start of a full-fledged uptrend in yields.

“It’s true the moves were a bit volatile,” one of the officials said on condition of anonymity. “It would be problematic if yields test the upper limit of the BoJ’s target range. Judging from recent moves, that’s unlikely to happen.”

The 10-year bond yield briefly jumped 6.5 basis points to -0.160% on Tuesday, before pulling back to -0.165% on Wednesday.

BALANCING TOUGH, BUT DOABLE Under its yield curve control (YCC) policy, the BoJ pledges to guide short-term rates at -0.1% and the 10-year yield around 0%.

The policy is aimed not only at keeping borrowing costs ultra-low, but at preventing excessive falls in long-term yields that would strain financial institutions’ margin.

Global economic uncertainties, however, have repeatedly pushed the 10-year yield below the -0.2% level, seen by markets as the BoJ’s line in the sand. That has dragged on super-long yields.

BoJ officials concede that putting a floor under rates is tougher than capping them as it requires trimming bond buying, a move that could be seen as a withdrawal of stimulus and trigger an unwelcome rise in the yen.

Still, the BoJ will likely rely on verbal jawboning and market operations to rein in sharp yield falls for now, rather than take bolder steps such as an overhaul of its policy framework, say sources familiar with its thinking.

Specifically, the central bank — which already owns 40% of the JGB market — will continue to slow bond buying, carefully timing the moves when markets are fairly stable, they said.

“The BoJ will act against excessive falls in super-long yields. It will also try to allow market forces to drive yield moves to some extent,” one of the source said. “Striking the right balance is tough, but doable.”

Some market players, however, doubt whether the BoJ can keep controlling yields with such modest steps, when heightening global uncertainties leave markets vulnerable to sharp swings.

The BoJ may also struggle to keep alive market expectations of near-term easing, without crushing long-term yields.

Faced with escalating global risks, the BoJ has signaled its readiness to ease as early as its Oct. 30-31 rate review. Kuroda has said any easing would aim at lowering short- to medium term rates, without flattening the yield curve. He did not elaborate on how the BoJ would do this.

“There are plenty of investors waiting to buy JGBs the moment yields rise,” said Shuji Tonouchi, senior market economist at Mitsubishi UFJ Morgan Stanley Securities. “It’s unclear whether bond markets will move in a way the BoJ wants.”