Yen jumps, JGBs slump on reports BoJ mulling policy changes at 31 July meeting

Japanese capital markets are in focus at the start of the week, following reports that rate-setters in Tokyo were mulling ways to reduce the potential side-effects from its so-called policy of 'yield curve control' and of making it more sustainable.

Their aim, according to multiple reports at the weekend, was to allow for "a more natural rise" in longer-term interest rates.

In response, overnight the yield on the benchmark 10-year Japanese government bond popped six basis points higher to 0.09% and that on 30-year debt by five and a half basis points to 0.74%.

Predictably, dollar/yen fell on the news, hitting an intra-session low of 110.75, as the Japanese currency strengthened versus the dollar, and was down by 0.34% to 111.102 as of 0809 BST.

Officials at the Bank of Japan reacted immediately, offering to purchase unlimited amounts of 10-year JGBs at a fixed rate of 0.11%.

JBG yields pulled back after the announcement, but currency traders were apparently unfazed, with the yen initially holding onto its gains - although no sellers of JGBs materialised.

The BoJ was next set to decide on policy on 31 July, while the Ministry of Finance was scheduled to sell 400bn yen ($3.6bn) of debt on Tuesday.

Since 2016, the BoJ had been pursuing an active policy of keeping 10-year interest rates at around 0% (in effect capping any rise at 0.10%) in a bid to keep inflation-adjusted interest rates as low as possible in order to help move the economy out of its deflationary rut.

Contrary to the expectations of some observers, it had managed to more-or-less pull off that trick even as rates had been moving higher in the US; indeed, it had even been able to "dramatically" reduce the pace of government bond purchases, currently at 46.5% of outstanding JGBs, Capital Economics explained.

Concerns around the negative side-effects of 'yield curve control' on Japanese lenders' profitability and their willingness to lend were legitimate, said Capital's Marcel Thieliant.

Yet he believed those worries were misplaced; although at some point lenders might be forced into mergers with rivals if their capital ratios continued to decline, up until now that had been more the result of tighter regulations.

Furthermore, in the long-run such mergers would in fact help their pricing power and help buttress lending.

"While ultra-loose policy creates some challenges for banks, tightening would overall result in a more difficult business environment. As such, QQE is likely to remain in place until inflation rises much higher."

Michael Every at Rabobank was more circumspect, telling clients: "Given they are also not exactly thrilled with a flat yield curve that is hurting banks, and with themselves rapidly becoming the sole owners of the entire JGB market, as well as a fair slice of the equity market, on Friday it was suggested they would be reviewing their Yield Curve Control (YCC) pledge to keep 10-year yields around zero (meaning up to 10bp).

"Before you could translate 'Debt coming due and we are raising rates? Really?' into Japanese, JGBs were being smashed and JPY was turning from 113 back towards 111. [...] In short, they are on a smooth and rapid shinkansen towards quasi-monetisation of one of the world's largest bond markets - and yet attempts to get off means the light at the end of the tunnel is another bullet train coming straight towards them."