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BoJ sticks to loose monetary policy sending yen sharply lower

The Bank of Japan has renewed its pledge to keep bond yields at zero, widening its policy gap with the central banks of other major economies raising interest rates to contain rising inflation.

The BoJ’s decision to stick with its ultra-easy monetary policy exacerbates the global divergence in yields after the Federal Reserve hiked its key interest rate by a historic 0.75 percentage point this week, prompting Switzerland and the UK to also to raise interest.

The BoJ held the overnight interest rate at minus 0.1 percent on Friday. It said it would make daily purchases of 10-year bonds at a yield of 0.25 percent, and showed no willingness to let bonds trade in a broader band.

Japan’s core consumer prices, excluding volatile food prices, have risen at the fastest pace in seven years due to rising commodity prices. But the BoJ has long argued that underlying demand in the economy remains weak.

The central bank is more confident than its counterparts in Europe and the US that the current inflation wave will be temporary and that it should continue to support the economy with monetary easing measures.

“Extremely high uncertainties remain for the Japanese economy,” the BoJ said in a statement, citing the disruptions from Covid-19, the war in Ukraine and rising import costs of raw materials and other goods.

“In this situation, it is necessary to pay due attention to developments in the financial and foreign exchange markets and their impact on Japan’s economic activity and prices.”

The decision caused the yen to plunge sharply to ¥134.28 against the dollar, extending a phase of exceptionally volatile trading.

Prior to the announcement, some analysts had predicted that BoJ governor Haruhiko Kuroda could try to address the recent dip in the yen with a small policy adjustment. When that didn’t happen, traders in Tokyo said the yen may fall further.

Benjamin Shatil, forex strategist at JPMorgan in Tokyo, said the decision showed the BoJ was “on its heels again”. But he notes that the bank seems to be hardening its tone by saying that it will pay due attention to developments in the financial and foreign exchange markets.

The implication for the yen, he said, is that a move towards the highs of the ¥130s against the dollar is now in sight, and it could even reach ¥140.

“With the BoJ apparently impervious to the wave of aggressive global central bank capitulation, unconcerned about the expansion of imported price pressures in Japan, and apparently willing to sell the entire stock of [10-year Japanese government bonds] if necessary to maintain yield curve control, the pain for the yen appears to be moving from acute to chronic,” said Shatil.

The BoJ’s decision comes as JGB trading continued to pose a direct challenge to the central bank’s determination, in particular to its commitment to keep the yield curve in check by keeping the yield on the 10-year benchmark within 0.25. percent on either side of zero.

After breaking that line repeatedly this week, the BoJ intervened with massive purchases of JGBs on top of the standard unlimited daily purchase offer it uses to reassure the market of its commitment to policy.

On Friday morning, the 10-year JGB yield reached 0.265 percent, its highest level since January 2016.

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