The Bank of Japan (BOJ) has taken a significant step towards normalising its monetary policy by rephrasing the 1% upper bound on 10-year Japanese government bond yields as a “reference” rather than a rigid cap, according to a Swiss Re Institute report.
This move effectively removes the cap on bond yields, although the BOJ retains the option to intervene if yields experience disruptive changes.
Inflation data indicates sustainable wage-price increases, prompting expectations of a full exit from negative interest rate policy (NIRP) and yield curve control (YCC) by mid-2024, pending the outcome of spring wage negotiations.
Japanese life insurers are anticipated to gradually increase their purchases of Japanese government bonds (JGBs) at higher yields. The risk of a yield spike triggering a liquidity crunch, similar to the situation in UK pension funds, is currently assessed to be moderately low, due in part to the limited use of leverage among Japanese institutional investors.
While the BOJ’s policy adjustment may lead to some upward pressure on global yields, the impact is expected to be muted, with Japanese investors still inclined to add to their holdings of US Treasuries rather than repatriate funds.
The BOJ’s decision aligns with strengthening inflation fundamentals and a broadening of service sector inflation in tandem with resilient economic growth. Japan’s largest labor union, Rengo, has indicated a target of “5% or more” wage increases in the Spring 2024 negotiations, signaling a potential boost to consumer spending.
Japanese insurers, although eager for higher yields, are exercising caution in their approach, anticipating further shifts in BOJ policy. The weak yen and expected higher energy prices are contributing to higher inflation expectations.
While the BOJ maintains the option to use large-scale JGB purchases to control yields, analysts suggest that yields may temporarily overshoot fair value in 2024 before settling closer to 1.2% by year-end, as other central banks consider policy adjustments.
