The Yen is weaker after the Bank of Japan threw out the central bank rule book

Photo by Junko Kimura/Getty Images

Milton Friedman would be rolling in his grave, but stocks in Japan are rising and the Yen is weakening after the Bank of Japan threw out the central banking rule in what it has called “QQE with Yield Curve Control” .

Under this plan the bank says the new policy framework consists of two major components:

  • the first is yield curve control in which the bank will control short-term and long-term interest rates; and
  • the second is an “inflation-overshooting” commitment in which the bank commits itself to expanding the monetary base until the year-on-year rate of increase in the observed consumer price index (CPI) exceeds the price stability target of 2 percent and stays above target in a stable manner.

Earlier this week the Bank of International Settlements, the central authority in the global banking system, questioned the wisdom of the current round of negative interest rates and QE which had flattened the yield curve and threatened bank viability.

So the first measure in the BoJ’s two pronged approach is aimed at bringing some slope back into the yield curve which will underpin the Japanese banking system.

Specifically the BoJ said it was leaving the penalty rate for excess reserves held with the bank at -0.1% but that it was going to conduct its bond buying program in such a fashion as to ensure that “10-year JGB yields will remain more or less at the current level (around zero percent)”. It left the amount to purchased at a Y80 trillion per annum pace.

But it is the abandonment of the monetary base target and the commitment to continue to expand that base until the rate of inflation hits and holds at 2% that is the big departure from current central bank orthodoxy.

In this age of inflation targeting and monetary policy by interest rate announcement it is easy to forget that for a long time central banks managed interest rates via the money supply. The monetarists, let by Friedman and the Bundesbank asserted that in control the money supply central banks could contain inflation. And central banks used to increase and shrink the money supply by injecting or withdrawing funds in order to achieve a target rate.

We were still doing it in Australia when Bernie Fraser was governor of the RBA.

So this move from the Bank of Japan is perhaps not so much a departure of the rules that Freidman, the Monetarists and the Bundesbank would have asserted but rather an embrace of monetarism as the last hope of reflating the economy and causing inflation.


Having collapsed to 101.20 in the hour before the announcement USDJPY rallied hard to a high of 102.78 in the wake of the decision. That level is one being closely watched by Forex traders as it represents a trendline from January highs at 121.45.

A short time ago USDJPY had backed off into the 102.50 region.

That means that forex traders are either not yet convinced the BoJ’s new plan will work. Or they are reluctant to take the Yen lower, USDJPY higher, with the Fed announcement out at 4am AEST tomorrow morning.

Nikkei traders are not so circumspect they have taken the index 1.69% higher with the banks leading the charge. Bond traders on the other hand seem like a more difficult sell with the 10-year JGB currently trading at -0.05% from a high of -0.02% earlier in the day.

So far the yield curve hasn’t materially steepened in response to the BoJ action.


Japanese yield curve –