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Japan Rate Hike's Global Ripple Effect

Japan Rate Hike's Global Ripple Effect

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As policymakers worldwide rush to tighten monetary policy and curb inflation, Japan’s central bank is nearing a modulation point, CNBC wrote.

Last month, the Swiss National Bank shocked markets by approving its first interest rate hike in 15 years. The surprising decision propelled the Swiss franc to its strongest level against the euro over the past two months.

Japan prioritizes yield curve control

Japan, on the other hand, aims to prioritize yield curve control. The country has been in a low inflation and low growth economic environment for many years, which means its central bank sustains accommodative policy in an effort to stimulate the country’s sluggish economy.

BOJ is the only central bank buying assets

The Bank of Japan (BOJ) planned to buy around $110 billion (15 trillion Japanese yen) of government debt last month, making it the only major central bank still buying assets in significant amounts.

The country’s inflation is just 0.8% and CPI is running just above the 2% target. BOJ faces very little inflationary pressure, but is this about to change?

Consistent focus on avoiding deflation

Japan’s main policy problem is avoiding deflation. After the influence of energy costs diminishes, BOJ expects consumer price increases to decelerate.

However, this might not pan out. The BOJ might have to raise interest rates like all other leading economies. This could result from monetary tightening steps across the globe and the associated effect, sending a ripple effect through world markets.

Japan’s payment balance and the degree, to which rate changes elsewhere buffet flows may determine future developments according to Capital Economics expert Neil Shearing. He wrote to CNBC in a note:

Japan is open to global capital flows and so, as bond yields in other countries have moved up, the BOJ has found that its commitment to a policy of Yield Curve Control – keeping 10-year JGB (Japanese government bond) yields within a 25 basis point band either side of zero – has been tested by global investors.

Supporting growth by keeping borrowing costs low

BOJ has a bond yield ceiling in place, which keeps borrowing costs down, thereby supporting growth. Shearing’s note added:

The recent sell-off in global bond markets has pushed the 10-year JGB yield right to the upper limit of the BOJ’s range, forcing it to purchase increasing amounts of government debt to maintain its target – by some measures, if it carried on buying at this month’s pace, it would own the entire market of outstanding JGBs within a year.

Even as global processes push rates up, BOJ continues to defend its yield target. This has put immense downward pressure on the Japanese yen.  

Japan’s open capital account is relatively open, which means it can either sustain sovereign monetary policy or control the yen. BOJ can protect the yen from devaluation or send it into a downward spiral by purchasing large quantities of bonds, but it can’t do both at the same time.