BOJ Switches To Yield Curve Targeting

New Policy Framework

The September Bank of Japan Monetary Policy Meeting saw the bank keeping rates on hold at current levels with QQE also maintained at the current level. However, the bank did introduce a new policy framework; “QQE with yield curve control.”

This new framework sees the bank discarding the average maturity of their JGB purchase program which had been set at 7 – 12 years ahead of the meeting. The bank will now target JGB purchases to keep 10Y yields around 0% and as such has moved into a yield targeting mode. The BOJ noted that excessive falls, flattening of the yield curve could have an adverse impact on the economy by hurting sentiment.

The bank notes that they will still buy JGBs around their current pace but the focus will instead shift to yield curve management and away from the pace of QE expansion. The bank has also announced two new operations to help them achieve this target; outright purchases of JGBs with yields designated by the bank and fixed-rate funds-supplying operations for a period of up to 10 years.

This adjustment to the bank’s policy framework indicates that the BOJ is gradually moving to focus more on targeting a steeper yield curve than an expansion in quantitative easing. Whilst the bank didn’t announce the start of tapering they did note that the expected pace of JGB purchases will be “more or less” in line with its current pace, suggesting room for flexibility around that pace.

It is early days for the bank’s two new operations but if they prove to be effective and the banks feel confident in them, they may start to gradually reduce JGB purchases whilst allowing room for a subsequent increase in JGB purchases as yields increase.

ETF Purchases Tweaked

Alongside the introduction of the new policy framework the bank also amended its ETF purchase program. The bank now intends to purchase Y2.7trln of ETFs linked to TOPIX out of their total Y6trln ETF purchase program.  This amendment is viewed as positive for equity markets with the sustainability of the bank’s purchase program strengthened by this change.  The pace of purchases will be kept at current levels.

Forward Guidance

The bank also adjusted their forward guidance and have noted that they will allow overshooting in inflation. The BOJ plans to continue to expand its monetary base until such a time as the YoY increase in CPI exceeds the bank’s price stability target of 2% and continues to hold above this level. This clearly rules out any tightening on behalf of the bank whilst inflation runs below 2%.

Referring to the monetary base, the statement noted that “the bank will continue expanding the monetary base,” however, no specifics were given as to whether the bank would maintain the rate of increases in the monetary base. This suggests that as long as the bank is comfortable with its yield targeting operations, there is the possibility of tapering in the future.

FX Impact

Despite the Bank leaving rates on hold at the current level, risk sentiment has thus far responded resiliently, and yield increases have thus far been muted. With attention now firmly fixed on the September FOMC meeting, USDJPY reacted in a very subdued manner and biggest moves were seen in the JPY crosses with JPY dropping sharply in response to the news only to recover shortly after.

Looking Ahead

The key focus of the week is, of course, the US FOMC rate decision tonight. Although the meeting is not expected to see the bank adjust policy, traders are anticipating Hawkish signals from the bank essentially confirming that the Fed will move on the rate before the year end.

Following this meeting, we also have the Reserve Bank of New Zealand rate decision which could see the bank retreating from recent Dovish rhetoric given a broad uptick in economic data and a rebound in dairy prices.