Examining Japanese Yield Curve Control and a focus on UK & US interest rates (2024)

Spotlight: Japan Yield Curve Control Policy

The Bank of Japan (BoJ) has employed yield curve control (YCC) as a means to achieve its economic objectives. YCC is typically used to control inflation, promote economic growth and/or manage interest rates in the financial system. A central bank can implement YCC by impacting supply and demand through buying or selling government bonds at a particular tenure, to ensure the market interest rate aligns with the central bank’s target. This week the BoJ made another adjustment to its YCC policy, bringing the Japanese central bank a step closer to phasing out the policy that’s been in place for almost a decade. Prior to July this year, the BoJ had a fixed ceiling of 0.5% on the yield of 10-year bonds, where they then decided to increase it to 1%. They have now redefined it as a loose upper bound rather than a hard cap.

Examining Japanese Yield Curve Control and a focus on UK & US interest rates (1)

Source: Factset, Data from January 2018 – October 2023.

The YCC policy in the past has come at a cost to the country, causing distortions in financial markets as well as an undesirable drop in the value of its currency. By relaxing the control over the 1% ceiling, long-term borrowing rates will be allowed to increase to levels that were previously considered off-limits. This will motivate banks to lend more money and encourage businesses to invest more into the economy, ultimately leading to economic growth.

Whilst other major economies have sharply increased interest rates over the past year to control inflation, Japan has stood apart by maintaining a target policy, or short-term rate of -0.1%, making it the only country in the world with a negative interest rate. At the same time, inflation has remained above the BoJ’s 2% target and ongoing cost related pressures (largely driven by oil prices), has led the BoJ to anticipate even higher inflation in 2024. With the combination of increasing inflation and the impact of a weaker currency, it appears ever likely that this will mark the end of negative interest rates for Japan in the new year.

The noise

The US Federal Reserve kept interest rates unchanged on Wednesday, maintaining its 5.25%-5.50% range. Policymakers struggled with the challenge of gauging whether current financial conditions are already restrictive enough to continue to curb inflation, or if a robust economy, which continues to exceed expectations may still need more restraint. The Fed had faced criticism that holding interest rates at higher levels could put the economy at risk of recession, but the economy grew much better than expected in Q3, growing by 4.9%.
Eurozone inflation rose just 2.9% in the 12 months to October, down from September’s reading of 4.3%. This is the smallest rise in over two years, though the sharp decline from double-digit figures a year ago is taking a toll on the eurozone economy, with it contracting by 0.1% in the three months to September. The two latest inflation and growth figures mean the ECB has almost certainly finished raising interest rates, and they will likely watch the effects of their hiking cycle play out before making further moves.
Belgium is set to join the Netherlands in implementing stricter environmental regulations surrounding the export of oil, as it looks to cut the exports of low-quality gasoline and diesel to West Africa. The Amsterdam-Rotterdam-Antwerp hub is the world’s leading gasoline exporting region, so once the legislation is signed the whole region will be aligned in cutting the supply of fuels proven to cause significant health problems. A downside of this will likely be an increase in costs for gasoline in West Africa, but Belgian lawmakers are adamant that no compromises should be made when it comes to products that pose environmental and health risks.

The numbers

GBP Performance to 02/11/2023

Equity GBP Total Return	1 Week	YTD
MSCI ACWI	3.1%	9.3%
MSCI USA	3.6%	12.8%
MSCI Europe	2.2%	5.8%
MSCI UK	0.8%	3.5%
MSCI Japan	3.6%	9.5%
MSCI Asia Pacific ex Japan	1.2%	-3.8%
MSCI Emerging Market	1.4%	-1.3%
MSCI EAFE Index	2.5%	5.4%
Fixed income GBP Total Return
UK Government	1.8%	-4.1%
Global Aggregate GBP Hedged	1.0%	0.7%
Global Treasury GBP Hedged	0.8%	0.8%
Global IG GBPHedged	1.2%	1.0%
Global High Yield GBP hedged	1.7%	5.2%
Currency moves
GBP vs USD	0.6%	1.0%
GBP vs EUR	0.0%	1.7%
GBP vs JPY	0.7%	15.9%
Commodities GBP return
Gold	-0.6%	7.9%
Oil	-1.7%	5.8%

Source: Bloomberg, data as at 02/11/2023

The nuance

Following the US Federal Reserve’s lead, the Bank of England left interest rates at their 15-year high of 5.25% on Thursday. They reiterated their stance that there would be no rate cuts any time soon, as the BoE fights to “squeeze out of the system” the highest inflation of the world’s big rich economies. However, the BoE made the gloomy statement that the economy was close to a recession and that they didn’t expect any meaningful growth in the coming years. Warning against complacency, Governor Andrew Bailey said inflation is still too high, and that the Monetary Policy Committee will be watching closely to see if further increases are needed.

With various developed world central banks hitting pause on further interest rate hikes in the last couple of weeks, focus in financial markets has shifted to when central banks will start easing policy as economic growth slows and inflation eases. For the UK economy, there wasn’t a clear consensus, with some economists pointing to Q2 2024, and others predicting we’d have to wait until 2025 to see a downward movement in rates.

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