The challenges that the Bank of Japan (BoJ) faces when it comes to monetary policy have changed noticeably in recent months. Initially, global factors in the form of the sharp rise in yields on US Treasury bonds put the interest rates on Japanese government bonds (JGBs) under pressure. From November 2018 onwards, the key factor has mainly been an outflow movement not induced by monetary policy. The fact that 10-year JGBs at the end of the year actually slipped into negative territory temporarily was an “occupational accident” in thin trading comparable to the “flash crash” on the foreign-exchange markets. Yet even after the latest correction, JGB yields have not succeeded in significantly climbing past the 0.00% mark. The latest trend in the JGB market may fit into the picture of domestic developments in Japan, especially the setback as regards inflation and growing economic concerns. We should not trick ourselves into thinking, however, that it is the cause of lower JGB interest rates; instead, the link is more temporal than causal.
The decrease in yields outlined above is of course water on the mill of the monetary policy doves. If they were to have their say, then (despite the BoJ’s promise of an interest rate of zero) a continuation of the drop in rates well into negative terrain would be accepted, if not even benevolently welcomed. The other BoJ members presumably focus more on the negative side-effects of the long period of a low-interest regime (bank earnings, trading activities in the JGB market drying up, etc.) and will therefore reject an exaggerated deterioration in interest rates as being as problematic as raising rates.
We do not expect that a majority will emerge within the Bank of Japan favouring a renewed expansionary policy, not to mention the issue of how such could even function given the fact that the range of available tools has been as good as exhausted. The demonstrative suggestion that negative yields are definitely acceptable, meaning that the “flexibility” in yields practised in monetary policy since July could also apply downwards, would definitely sit well with current sentiment. At any rate, any Bank of Japan exit from its ultra-expansionary policy has now become very remote again. The Yen should also bear this in mind should it be tempted in the absence of Fed interest hikes or given (more or less latent) risk aversion in the context of the Brexit chaos to try to gain ground against other currencies.