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BOJ's lone battle against rising yields accelerates yen's slide

Weak currency risks exacerbating inflation, current account deficit

The Bank of Japan is maintaining large-scale monetary easing even as counterparts at other developed economies start to tighten their monetary policy amid inflationary pressures.   © Reuters

TOKYO -- Struggling to ward off upward pressure on interest rates, the Bank of Japan on Monday tried to defend its ultra-loose monetary policy with bond purchase operations, sending the Japanese currency tanking to a seven-year low.

The BOJ's signal to keep the benchmark yield on 10-year Japanese government bonds below the 0.25% target bucks the global trend of other central banks raising interest rates to rein in inflation. The BOJ's go-it-alone stance could exacerbate the yen's slide, which in turn could worsen the current-account balance and accelerate inflation.

The BOJ first announced one-time fixed-rate purchase operations after the yield on 10-year JGBs hit 0.245%, approaching the BOJ's target ceiling of 0.25%.

The yield then sank to 0.24%, which meant the market price for the bonds topped what the BOJ was actually offering, and the bank later announced it had no takers on its morning offer.

But continued selling pressure lifted the yield to 0.25% later that afternoon. The BOJ responded with a second offer and ultimately purchased 64.5 billion yen ($528 million) worth of JGBs.

Still, the yield refused to budge, prompting the BOJ to announce the same purchase operation starting from Tuesday to Thursday. This forceful move sparked speculation about widening yield spreads, with the Japanese currency hitting 125 yen to the dollar, the lowest since August, 2015. 

Japan had also faced rising rates in February, but that was largely a ripple effect from the U.S. Federal Reserve and other central banks overseas signaling a tightening in their monetary policy.

Concern over inflation is contributing to upward pressure on yields. From crude oil to grains, global commodities prices have surged after Russia invaded Ukraine. Japan's consumer price index is seen potentially growing by over 2% on the year starting in April.

The BOJ has kept long-term rates at around 0% and short-term rates at minus 0.1% under its yield curve control strategy. But keeping rates down as other central banks move in the opposite direction widens interest rate spreads and weakens the yen. This in turn could weigh heavily on Japanese companies and households, especially when combined with rising commodities prices.

"If U.S. rate hikes or a weak yen again exerts upward pressure on long rates, and the BOJ responds with another fixed-rate operation, it could trigger a negative spiral that further devalues the yen," said Ryutaro Kono, chief Japan economist at BNP Paribas Securities (Japan).

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