Bank of Japan maintains low interest rates but makes yield control policy more flexible

The Bank of Japan has maintained its ultra-low interest rates but taken steps to make its yield curve control policy more flexible, underscoring growing concerns over the rising side-effects of prolonged monetary easing.

At the two-day meeting that ended on Friday, the central bank kept unchanged its short-term interest rate target at minus 0.1 per cent and that for the 10-year government bond yield around zero per cent.

It also maintained guidance allowing the 10-year yield to move 0.5 per cent around the zero per cent target, but said those would be “references” rather than “rigid limits”.

The BoJ will offer to buy 10-year Japanese government bonds at 1 per cent in fixed-rate operations, instead of the previous rate of 0.5 per cent.

“Sustainable and stable achievement of 2 per cent inflation target, accompanied by wage increases, has not yet come into sight,” the central bank said, adding that it will patiently maintain an ultra-loose policy.

“Taking into account extremely high uncertainty on the economic and price outlook, it is appropriate to enhance the sustainability of monetary easing under the current framework by conducting yield curve control with greater flexibility and nimbly responding to upside and downside risks.”

While inflation has held above the BoJ's 2 per cent target for more than a year, Governor Kazuo Ueda has vowed to keep ultra-loose policy until he is convinced the economy can weather global headwinds and allow companies to keep raising wages next year.

But sources told Reuters the board may discuss making minor tweaks to the policy if the BoJ feels the cost of yield curve control is beginning to outweigh the benefits.

The Nikkei newspaper reported earlier on Friday that the central bank will maintain its 0.5 per cent cap for the 10-year government bond yield, but discuss allowing long-term interest rates to rise above that level by a certain degree.

The BoJ's meeting comes after the Federal Reserve's decision on Wednesday to raise interest rates, a move that further widens the interest rate gap between the US and Japan.

Since introducing yield curve control in 2016, the Bank of Japan had little trouble controlling bond yields when inflation remained well below its target.

That changed last year, when soaring commodity prices pushed inflation above the 2 per cent target and gave investors reason to attack the yield cap.

After buying huge amounts of bonds to defend ceiling of 0.25 per cent at the time, the BoJ last December widened the yield band and now allows the 10-year yield to rise by up to 0.5 per cent.

With wages and inflation rising, markets have been simmering with speculation of an early tweak to yield curve control.

Data released on Friday showed core consumer inflation in Japan's capital slowed in July but remained well above the central bank's 2 per cent target, underscoring rising price pressure.