A Japanese national flag flies outside the Bank of Japan (BOJ) headquarters in Tokyo, Japan. (Photographer: Kiyoshi Ota/Bloomberg)

Japan's Central Bank Is Roiling Markets

(Bloomberg) -- The Bank of Japan’s most significant policy changes to its massive monetary stimulus in two years quickly injected life into the government bond market. BOJ Governor Haruhiko Kuroda said the central bank would permit the benchmark 10-year yield to trade a bit more widely, and pledged to keep rates at extremely low levels for an "extended period." Economists disagreed on whether the BOJ had enhanced its stimulus or taken a tiny step toward unwinding it. As central banks in the U.S. and Europe move away from crisis-era policies, investors are asking how long the BOJ can continue with its own stimulus program, and how high yields could go in the meantime.

1. Why are Japanese bond yields swinging so wildly?

Yields began to rise in July in response to news reports that BOJ policy makers were debating taking steps to address some of the side effects of the five-year old stimulus program, such as undermining bank profitability and distorting bond markets. On July 31, the BOJ confirmed that the benchmark 10-year yield would be allowed to move up and down a bit more freely. Kuroda said the previous trading range -- assumed by the market to be 0.1 percentage point on either side of 0 percent -- would be permitted to roughly double. As the market digested the conflicting signals, the yield tumbled by the most in nearly two years. It rebounded two days later to an 18-month high of 0.145, before the central bank unexpectedly purchased bonds in a so-called special buying operation, pushing the yield back to 0.115 percent.

2. Why did the BOJ do that?

The surprise market operation two days after the policy meeting -- and three unlimited purchase offers in the days ahead of it -- were meant to stifle rapidly rising yields. Any additional sharp jumps in the long-term yield are likely to trigger more action from the BOJ. Deputy Governor Masayoshi Amamiya explained that the central bank won’t tolerate a race toward 0.2 percent.

3. Why is the BOJ buying bonds in the first place?

To rescue Japan from nearly two decades of deflationary pressures. At its start, the core of Kuroda’s stimulus program was buying hundreds of billions of dollars worth of government bonds a year. The aim was to push interest rates lower and drive businesses and households into riskier investments. This was expected to stimulate economic activity and raise prices, with a goal of reaching 2 percent inflation and self-sustaining economic growth. While progress has been made, the goals remain elusive.

4. What’s happened to those purchases over time?

Officially, the BOJ’s target of expanding its JGB holdings by 80 trillion yen ($718 billion) annually remains in place. In reality, its buying has fallen to just above half that pace. The drop has quickened since the central bank shifted the primary focus of its stimulus to controlling interest rates in September 2016. Its stated rationale for the change was policy sustainability.

5. Is the BOJ effectively tapering?

The bond buying has certainly plummeted, leading to speculation that it would drop the 80 trillion yen target -- a pace that is widely considered unsustainable. Yet under yield curve control, the BOJ said it would buy only as many bonds as it needed to maintain the 10-year yield at its target, and it has accomplished that. Kuroda has said the decline in the amount of government debt available for purchase -- the BOJ owns about 40 percent of the market -- means the central bank can get the same effects by buying less debt.

6. Why does it matter what happens with JGB yields?

First, the BOJ’s bond purchases have ramifications for global markets. Japan is the world’s biggest creditor -- its net $2.95 trillion international portfolio investment position is 26 percent bigger than Germany’s and 60 percent larger than mainland China’s. If higher Japanese yields cause even some of that money to flow back into the nation’s bonds, it would hurt demand for overseas debt and equities markets. It would also strengthen the yen, making imports cheaper and weakening inflation, undermining the BOJ’s efforts.

7. What’s next?

With market sensitivity to Japan’s monetary policy heightened, any shift in the amounts purchased at regular bond-buying operations could trigger a jump or slide in the yen, even though Kuroda said such changes don’t have policy implications.

The Reference Shelf

  • What BOJ Watchers say about last week’s monetary policy tweaks.
  • A Bloomberg View column on how the BOJ has created a cover for stealth tapering.
  • A QuickTake Q&A on BOJ’s 2 percent inflation goal.
  • The latest BOJ policy meeting result in detail.

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