Alicia García Herrero (Natixis) | As the Yen rapidly depreciates above USDJPY=120, the unintended consequences of the Bank of Japan (BoJ)’s Yield Curve Control (YCC) has become increasingly apparent. Last month, the BoJ announced it would intervene in the JGB market to protect the 0.25% ceiling on the 10-year JGB yields as they were being pushed up by higher US Treasury yields. Furthermore, after the Fed began to tighten last week, the wider interest rate differential between the US and Japan has weakened the Yen significantly.
There is an immediate problem about a sharp fall in the Yen, namely the related erosion of real wage, which will dent private consumption. On the surface, inflation has been contained, with the core CPI at +0.6% YoY in February, well below the BoJ’s 2% target. However, companies have been cautious in transferring higher input costs to their customers, as import prices were already jumping at +34.0% YoY in February due to surging energy prices. Hence, with squeezing profitability, companies would face additional challenges to raise wages. Furthermore, because wage growth has been structurally weak, even a small rise in CPI inflation will be detrimental for real wages and private consumption.
These developments suggest that the BoJ’s extraordinary monetary policy has become self-defeating as it cannot co-exist with the tightening of major central banks, especially that of the Fed. The BoJ decided at the March meeting not to extend the additional purchase program of commercial papers (CPs) and corporate bonds beyond April, which were both introduced to stabilize the economy from the COVID pandemic, but it has kept the YCC as it was, which is the main reason for the current slide in the Yen.
We take the view that the pressure on the BoJ is bound to continue, which will eventually push the BoJ to take action on the YCC. In our previous report, we explained why the BoJ would need to expand the band in which the 10-year JGB yield can fluctuate. In particular we expect the BoJ to increase the ceiling to 1% for the 10-year JGB yield. This will allow the BoJ to gain some more flexibility to deal with tighter global monetary conditions and to prevent a rapid depreciation of the Yen, while still keeping an accommodative monetary policy to achieve its 2% inflation target