so they decided bank of japan unanimously on Wednesday to keep its ultra-low interest rates of 0.1 percent for short-term rates and the 0.5 percent ceiling for 10-year government bonds. It only slightly raised the inflation forecast for 2022 and 2024, to 3 and 1.8 percent, respectively, while expecting 1.6 percent this year.

In December, it surprised investors by doubling the interest rate corridor for 10-year government bonds (JGB) to just 0.5 percent. Most recently, the 10-year JGB interest rate exceeded the central bank’s limit for the fourth consecutive day of trading. Investors had increasingly bet that the central bank would further tighten monetary policy.

Investors had to cancel some of these bets. As a result, Japanese government bond yields fell more than they had in decades. Ten-year bonds fell from 0.505 percent to 0.360 percent. The two-year bond yield turned negative from 0.046 percent.

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The development is closely related to the expectations of market participants regarding the evolution of interest rates. When a central bank tightens monetary policy, bond yields typically rise.

The yen also came under severe pressure against many currencies. The Japanese currency fell more than two percent against the dollar and the euro. After all, investors in other currency areas have the prospect of higher interest rates and therefore higher returns.

By contrast, shares of large companies rose sharply as a weaker yen boosted their overseas sales. Japan’s main index, the Nikkei, jumped 2.5 percent.

Controversial monetary policy of the Bank of Japan

The strong swings underline the nervousness of the markets regarding the monetary policy of the third largest economy in the world. Since then, the US Federal Reserve fed in the fight against inflation has raised interest rates, hedge funds are betting against the Bank of Japan. They expect the Japanese monetary authorities to have to abandon their innovative policy of yield curve control, which is the basis of Japan’s current monetary policy. A change in monetary policy would be felt globally given the importance of Japan.

With yield curve control, the bank does not set a key interest rate, but instead controls the entire yield curve. Thus, it pushes interest rates on short-term bonds to minus 0.1 percent. For 10-year JGBs, the interest rate runner is around zero.

Longer-term bond rates allow them to move more positively to stabilize insurers that need longer-term bonds to cover their long-term liabilities. This policy is considered highly controversial because it is associated with high costs and, according to experts, distorts the market.

>> Read here: Loose monetary policy, big-spending tourists: Japan expects stock prices to rise

In December they had Boxwood surprisingly expanded the long-term trade corridor to the range between minus and plus 0.5 percent. You want to improve the functioning of the market, he said. The move has already sparked backlash in the markets.. Since December, the Bank of Japan has had to buy JGB for about 33 trillion yen (about 240 billion euros) to defend the ceiling of its interest rate corridor. It is also becoming increasingly difficult to find buyers for the bonds.

All this added to the confusion about the future course. The Investor Alliance Bernstein even warned this week that investments in Japanese government bonds should come to a complete halt due to falling liquidity. Bloomberg quoted a portfolio manager as saying the central bank had only two options to resolve the dilemma: break yield curve control or extend the maturity of interest-free loans from two to five years to keep banks going. encourage the purchase of government bonds. This could help ease the pressure on government bonds until the central bank’s March meeting.

Another problem: the greater influence of foreign investors. Until now, Japan has considered itself immune to pressure from international financial markets. Because most of the bonds are held in the country, while foreigners own only 14 percent of the debt. But because of the Fed’s huge purchases, they are now the second largest investor in the non-Fed controlled part of the market, after Japan’s insurers, and thus increasingly determine prices.

Bank of Japan: management change imminent

At the end of his ten-year term (he will step down in April), central bank governor Haruhiko Kuroda is under more pressure than ever to justify himself. Until now, he has always rejected rate hikes. The Bank of Japan expects inflation, which is low by international standards, to soon fall below its two percent inflation target. In November it was 3.8 percent.

He still gets away with a lot of economists. Stefan Anrick of Moody’s Analytics says: “The latest economic data does not call for a tightening of monetary policy.” He sees no signs of overheating the suit. Inflation is largely imported, the yen is strengthening after last year’s collapse and global inflation has peaked.

He does not want to rule out a politically motivated change in monetary policy with the new central bank leadership team. But Anrick says: “It’s hard to see what could justify a broader move away from low interest rates in general.”

More: Harvard economist Kenneth Rogoff talks about the state of the global economy

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