TOKYO -- The Bank of Japan's policy board meets again next Wednesday and Thursday against the backdrop of economic uncertainty that has driven long-term interest rates far below its target, worsening the side effects of its easing framework.
Other major central banks have been pivoting toward looser monetary policy. The European Central Bank decided this past Thursday to lower rates for the first time in three and a half years, and the U.S. Federal Reserve is widely expected to cut rates again this month after announcing a 0.25 percentage point reduction in July, its first in more than a decade.
But lately, markets have tracked government action more closely than central bank policy.
"The Japanese, U.S. and European central banks aren't players in the market right now. The biggest catalyst is [President Donald] Trump's comments," a senior BOJ official said.
For example, after the bank decided to hold rates steady at its July 30 policy board meeting, the yen weakened against the dollar, with the market having priced in a rate cut by the Fed the following day. But when Trump tweeted Aug. 1 to announce more tariffs on Chinese imports, the Japanese currency strengthened sharply as investors fled to a perceived safe haven.
At this point, the yen is softening again on hopes for progress on U.S.-China trade talks. It hovered around 108 against the greenback on Friday after Trump said the day before that he would consider an interim trade deal with Beijing.
The BOJ's short-term policy rate now stands at minus 0.1%. Sentiment within the central bank is growing that the current level of easing should be maintained if stocks hold firm and the yen remains weak. Even if the policy board decides not to push short-term rates deeper into negative territory, expectations of a Fed rate cut should keep the yen from strengthening too much, the thinking goes.
Long rates are a greater concern. The BOJ's yield curve control policy targets long-term rates of around zero, accounting for moves of around 0.2 point above or below this level.
But between late August and early September, investors poured money into Japanese government bonds amid concern about Sino-American trade frictions, driving yields close to minus 0.3% -- clearly outside the range of tolerance. On Sept. 4, the yield on benchmark newly issued 10-year JGBs reached minus 0.295%, the lowest level in more than three years.
In a Sept. 5 interview with Nikkei, Gov. Haruhiko Kuroda signaled that the BOJ would tolerate lower rates for the time being. This appears to be an effort to enhance the effect of the current easing framework.
But Kuroda also said that "if there's no limit at all, the interest rate target of 'around zero' will become meaningless."
Should the central bank let yields continue to slide, then even the 20-year yield could turn negative, causing further pain to pension funds and life insurers whose returns have already been dragged down by easing. Conversely, having the BOJ set out countermeasures could ease the side effects that have bedeviled financial institutions.
Long-term yields climbed to minus 0.16% in the Japanese market on Friday, up 5.5 basis points from Thursday's close. But observers expect the overall downward trend to continue as uncertainty hangs over the global economic outlook.
On top of the U.S.-China trade war, next month's consumption tax increase and the U.K.'s exit from the European Union, now due Oct. 31, also present downside risks. With limited policy options at hand, this will be a trying time for the BOJ.