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As yen slides, Japan clings to near-zero interest rates

BOJ's latest defense of ultraloose policy puts it further behind inflation-fighting curve

The yen has slumped against a broad range of currencies. (Photo by Takuya Ikeda)

TOKYO -- The Bank of Japan's latest move to defend ultralow interest rates shows its commitment to holding the line, even as it falls out of step with other big central banks and risks deepening a yen sell-off, analysts say.

With the yen weakening past 129 to the dollar for the first time in two decades Wednesday, Japan market watchers braced for a possible surprise from the BOJ: not pushing back against rising interest rates.

Instead, it doubled down. The BOJ bought Japanese government bonds to defend the upper end of its interest rate target range after the yield on benchmark 10-year JGBs touched 0.25%, and announced plans to buy unlimited amounts of bonds on four straight trading days starting Thursday

"That made clear that they're going to bring rising rates under control even if it means ignoring exchange rates," said Katsutoshi Inadome, senior bond strategist at Mitsubishi UFJ Morgan Stanley Securities.

Japan's ultralow interest rates are increasingly an outlier. The U.S. Federal Reserve has raised rates to fight inflation, and even some Asian emerging-market central banks have followed suit out of fears of capital flight. 

U.S. 10-year Treasury yields are approaching 3%, while the yield on comparable German bunds has climbed from negative territory at the end of last year to around 0.9%. Other European economies such as France and the Netherlands have topped 1%.

Two-year yields, which tend to be lower due to their shorter maturity, are now negative in only a few major economies including Japan, Switzerland and Denmark. Even the latter two countries have 10-year yields above 1%.

Bond yields were mired below zero across much of the eurozone after the European Central Bank introduced a negative-rate policy in 2014. But as a rally in natural gas and other commodities last year drove up inflation, later accelerated by Russia's invasion of Ukraine, the ECB was tapering its quantitative easing, Its smaller monthly bond purchases have allowed interest rates to rise.

The broad pivot to tighter monetary policy has sent the total amount of negative-yield debt worldwide plunging 85% since December 2020, to $2.6 trillion from more than $18 trillion, QUICK-FactSet data shows.

As Japan diverges more from other economies on monetary policy, the yen has slumped against a broad range of currencies. The largest drop among major currencies this month is against the dollar, at 5%, followed by the Swiss franc at 3% and the euro at 2%.

The yen is also around year-to-date lows against emerging-market currencies such as the Turkish lira and the Russian ruble.

Inflation exacerbated by the weak yen risks dampening business activity and consumer spending in Japan, sparking unusual warnings from Japanese officials about the downsides of depreciation.

BOJ Gov. Haruhiko Kuroda acknowledged Monday that the currency's "quite sharp" fall "could make it hard for companies to set business plans," a slight departure from his usually consistent stance that a weak yen benefits Japan's economy.

The yen rebounded against the dollar late Wednesday in response to a dip in U.S. interest rates. The 10-year Treasury yield has climbed well above what the Federal Reserve considers the neutral interest rate, and many market players see little room for further gains.

"It would be hard for the expected pace of U.S. rate hikes to go faster than this," said Yujiro Goto, head of forex strategy at Nomura Securities. "The yen will probably strengthen after testing 130 to the dollar."

But other analysts see more downward momentum to the yen and remain uncertain about how far it could fall.

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