Explained: The Bank of Japan's unexpected policy change

The Bank of Japan sprung took experts and markets alike by surprise after an unexpected policy shift.

The bank has loosened its longstanding shackles on bond yields – allowing long-term interest rates to rise.

The BOJ in a statement said the change aimed to “improve market functioning and encourage a smoother formation of the entire yield curve, while maintaining accommodative financial conditions.”

But what does this mean? Let’s take a closer look:

As per CNBC, the Bank of Japan in September 2016 announced its yield curve control mechanism.

That was done after a protracted spell of economic stagnation and ultralow inflation – with the aim of hiking inflation to its two per cent and countering anti-deflationary forces.

As per Moneycontrol, the bank, under that policy, could buy unlimited government bonds to keep yields within its desired bands.

This means yields are quite low – and even sometimes negative.

Though the low yields are thought to encourage investment, consumption and spending, Japan has not been successful in fending off deflation, as per Moneycontrol.

As per The New York Times, the trading of government bonds has nearly halted over the past few months.

The bank will now broaden its band on its 10-year bonds as well as increase its monthly purchases to $67 billion from around $55 billion.

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What does this mean?

The move to allow yields on certain government bonds to move in a wider band is seen as a precursor to a possible interest rate hike next year, finally bringing the central bank in line with others around the world.

The bank governor Haruhiko Kuroda at a briefing after the statement’s release declared that it was “too early to consider reviewing or exiting” its current easing policies, as per The Times.

Kuroda is expected to step down next year.

What do experts say?

That it’s too early to say.

“Maybe this is a baby step to test out the strategy and see what the market reaction is, and how much it’s reacting,” Bart Wakabayashi, branch manager at State Street in Tokyo told CNN.  “I think we’re seeing the first toe in the water.”

“The decision is being read as a sign of testing the water, for a potential withdrawal of the stimulus which has been pumped into the economy to try and prod demand and wake up prices,” Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, told CNBC.

However, she noted that the bank is claiming this is just ‘fine tuning’ and not the beginning of policy reversal.

“They’ve widened the band, and I guess that came earlier than expected. It raises questions as to whether this is a precursor of more to come, in terms of policy normalisation,” Moh Siong Sim, currency strategist at Bank of Singapore, told CNN.

“The writing’s on the wall that perhaps the sharp yen weakness that we’ve seen previously was uncomfortable for policymakers … it’s clear that it adds to the yen strength story next year.”

Yen soars on announcement

Tuesday’s announcement sent the yen soaring from above 137 per dollar to just above 130 – its strongest since August – while it also rallied against other peers including the euro.

And it managed to hold on to most of the advances on Wednesday.

Regional markets mostly edged back from a painful sell-off, though fears that borrowing costs will continue to rise globally next year were keeping any rally in check.

Tokyo was slightly lower again after dropping more than two percent Tuesday, though Hong Kong, Shanghai, Sydney, Seoul, Wellington, Taipei, Manila and Jakarta all rose.

The surprise move came as investors were already suffering following hikes by the US Federal Reserve and European Central Bank last week, and warnings by officials that rates would likely go higher than initially expected.

The tightening measures, aimed at bringing decades-high inflation under control – have fanned speculation that the world economy will be tipped into a recession.

“Tighter BoJ policy would remove one of the last global anchors that’s helped to keep borrowing costs at low levels more broadly,” said Deutsche Bank analysts.

And National Australia Bank’s Ray Attrill added that Tuesday’s “tweak has, whatever the BoJ (and government) will have us want to believe, been interpreted as putting the writing on the wall for a policy shift next year.

“It is also seen as signifying a formal end to tolerance/desirability of yen weakness.”

With inputs from agencies

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