On Tuesday, the Japanese yen experienced a significant decline following the Bank of Japan’s highly anticipated decision to terminate its long-standing hostile interest rate policy. Meanwhile, the dollar gained ground in anticipation of the Federal Reserve’s imminent rate decision.
In a landmark departure from years of extensive monetary stimulus, the Bank of Japan (BOJ) concluded its two-day monetary policy meeting by discontinuing eight years of negative interest rates and other unconventional policies. The move shifted the focus for markets, analysts, and investors to when, not whether, the BOJ will raise rates further. The 10-year Japanese government bond yield fell as much as 15 basis points to 0.36%, the lowest since September 2003.
Investors took the BOJ’s dovish guidance as a sign that the interest rate differential between Japan and the United States will gradually narrow. That sent stocks higher, with the benchmark Nikkei index .N225> rising 2.5%. The yen slipped to below 150 per dollar.
The BOJ, which has been aiming to lift inflation to 2% for more than a decade, said it would abandon its radical policy of directly controlling the yield curve on sovereign bonds and stop purchasing exchange-traded funds and real estate investment trusts. However, it would continue to purchase about 6 trillion yen worth of Japanese government bonds per month and adjust that amount quickly depending on economic trends.
Analysts gave the BOJ credit for showing determination and boldness in ending its ultra-loose policy, which had become increasingly controversial and risky as it pushed inflation further out of sight. But some questioned whether it could have gone further, especially as recent reports on inflation have been weaker than expected.
Some economists believe the BOJ’s new policy will not be enough to significantly lift inflation, and it may still have to resort to further easing measures, which could send the yen lower.
For the second time this week, the BOJ limited gains in an attempt to slow the rise in 10-year bond yields. This action weighed on the yen and stoked speculation about how far the central bank might allow yields to rise.
UBS economist Masamichi Adachi said he expected the BOJ to tolerate five basis point increases in its 10-year Japanese government bond yield. “This shows that the BOJ is prepared to ease further if needed,” he said.
Markets will look past the Federal Reserve’s meeting this week to see whether the Fed can add to the rate cuts it had planned to deliver this year, as recent data have been softer than expected. The Fed’s policy-making committee meets Wednesday to review the latest economic forecasts and decide on a rate path.