The Bank of Japan (BoJ) has been the sole holdout among central banks this year, refusing to abandon its near zero-interest rate target policy, but there are signs of cracking. The bank buys and sells government bonds in order to target a particular level of interest rates and, in late 2022, the bank surprised markets by announcing that it would expand its 10-year interest rates target to -0.5% to + 0.5% from the -0.25% to +0.25% range – signalling that the bank may be getting ready to tighten monetary conditions in the country.
Since the announcement, Japanese 10-year government bond yields have moved from 0.25% to 0.49% and the yen has strengthened 3% and 5% against the euro and dollar, respectively. The governor of the bank has maintained his stance that loose monetary policy would remain until (moderate) inflation took hold which has been hovering in and around 0% since the mid-1990s. However, a recent inflation reading of 4.0%, the highest level in 40 years, is putting pressure on the Bank of Japan to tighten its monetary policy.
The chart shows Japanese inflation versus Japanese 10-year bond yields. Bond yields (orange line) rose as inflation rose – up until 0.25%, at which point they were constrained by the BOJ’s bond-buying activity. Bond yields jumped once again when the policy shift was announced. Nonetheless, monetary policy remains extremely loose, with the real yield still negative at -3.5%.
So, if bond investors continue to sell bonds, the BOJ will be forced to increase its buying to keep 10-year bond yields under 0.5%, likely stimulating the Japanese economy. Relinquishing the struggle to bond investors would likely lead to a significant rise in interest rates. With rates at or near zero for a long time, and high government debt, who knows what landmines are hidden below the surface in the Japanese financial markets.
Given that monetary policy is still extremely loose around the world (interest rates have risen in the US, Europe, and UK, but are still below inflation), it is no surprise that gold has performed relatively well over the past few months.
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