BoJ Preview: Forecasts from 10 major banks, no change to policy, another tweak to YCC?

We don’t expect the BoJ to change policy at its upcoming meeting. There remains a chance it will drop its guidance that it won’t hesitate to take additional easing measures. It’s also possible that YCC could be tweaked given the upward pressure on bond yields. Changes to YCC – expanding the target range and/or shortening the duration – are possible in coming meetings and we expect YCC will be abandoned altogether by Q2 2024. The inflation outlook suggests 2% sustainable inflation isn’t going to be achieved within the forecast horizon implying any change to the policy rate remains some way off.

We expect the BoJ to stay on hold despite pressure to tighten on account of high inflation and challenges from a depreciating Japanese Yen (JPY). Still, we expect the BoJ to be patient and wait for a better time to change its policy, as it may seek to avoid past mistakes of premature policy tightening, which could depress economic growth and revive deflationary sentiment. 

The BoJ meeting will be suspenseful. The JPY is now trading above 150 against the USD and the 10Y Japanese government yield is not far from the 1% cap enforced by the BoJ. Something needs to give, either the BoJ will start to normalise policy or the JPY will continue to weaken. We believe however that markets most likely will get disappointed again by the BoJ.

The Japanese data indicated the economic recovery has lost some steam with composite PMI at 49.9, below the 50 threshold for the first time this year. Even so, we think the data supports another tweak of the yield curve control by the BoJ this year, most likely at the meeting ending on Tuesday, with the most likely move as an increase in the de facto 10Y yield cap to 1.5%. The recent surge in global yields has also prompted the BoJ to intervene in JGB markets several times recently.

Market consensus suggests that it is unlikely for the current policy settings to change, but we see a slightly higher chance of another YCC tweak with forward guidance changes. The market will also pay more attention to the BoJ’s quarterly outlook for growth and inflation. If the central bank revises up its fiscal year 2024 inflation forecasts to above 2%, the market is likely to take this as a hint that policy normalisation is fast approaching.

We expect the BoJ to revise its monetary policy framework but it is a close call. Even if the BoJ maintains its status quo, the YCC is likely to come under further pressure as expectations of policy normalisation build up.

We now expect the BoJ to tweak its YCC settings by widening the reference range for 10y JGBs to 1.5% (prior: 1.0%) and increasing the rate of its fixed rate purchase operations. We don't expect other policy levers to be adjusted. We expect the Bank is likely to signal that this YCC tweak again is a preemptive move given the upside risks from wages and prices. 

We see a 50-50 chance that the BoJ would raise its de-facto cap on the 10-year JGB yield from 1% to 1.5% due to rising concerns of widening yield differentials and mounting pressure on the Yen.

We now expect the BoJ to preemptively raise the backstop for YCC from the current +1.0% to +1.5%. It seems likely the BoJ thinks the underlying factors of rising US Treasury yields will not reverse in the near term. Therefore, the BoJ will likely perceive an increasing risk that it may have to buy a huge amount of JGBs through December if YCC is left unchanged. Meanwhile, the rise in domestic inflation expectations implies real interest rates would be unchanged even after the BoJ allows the 10-year JGB yield to rise slightly, meaning the easing policy stance would be kept unchanged. Governor Ueda will likely state that the revision was made in consideration of the balance between effectiveness and side effects. Regarding the wording of the forward guidance, any change towards tightening will be difficult as long as YCC exists.

We expect the BoJ to keep monetary policy on hold for now. That is, it will keep its policy interest rate at -0.10% and maintain the current YCC policy, which creates a hard upper bound of 1.00% for 10-year Japanese Government Bonds (JGBs). Overall, we maintain our view for no change, but we will be closely monitoring the BoJ's inflation forecasts for signs a policy adjustment could be coming closer in the months and quarters ahead.