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Expectations are rising that Japan’s central bank will loosen its grip on the bond market this week as the yen tests a 33-year low and government bond yields hit their highest in a decade.

But investors’ larger focus may be on whether Bank of Japan Governor Kazuo Ueda will provide decisive signals on inflation trends that could pave the way for Japan to end the world’s last wave of negative interest rates.

The yield on the benchmark 10-year Japanese government bond reached 0.89 percent last week, its highest level since July 2013. As a result, the BoJ is widely expected to revise – for the third time in 12 months – its unconventional “yield curve control” policy Purchases of government bonds to keep yields below a set level.”

“It feels like the market is expecting a change in yield curve control and is already starting to price it in,” said Jim Leaviss, chief investment officer of public fixed income at M&G.

The BoJ last changed the range within which 10-year Japanese government bond yields can trade in July. UBS now expects the bank to widen the range further on Tuesday, from 1 percent to 1.5 percent, and expects to raise its target 10-year JGB yield from zero to around 0.5 percent becomes.

Barclays expects the BoJ to completely scrap yield curve control on Tuesday.

However, Goldman Sachs, Nomura and Morgan Stanley MUFG say the central bank is likely to stick with its current monetary policy framework.

The BOJ was the only major central bank not to raise interest rates in the past two years, keeping its key interest rate at minus 0.1 percent despite inflation above target for 18 months.

But the widening gap between borrowing costs in Japan and the U.S. and Europe, as 10-year U.S. Treasury yields rose to their highest in 16 years, has put pressure on the BoJ to tighten policy amid the weakening yen.

The yen weakened against the dollar to above 150 yen last week, raising concerns about inflation as the cost of imported goods rises. The ¥150 level has previously prompted currency interventions from the Japanese authorities.

Although the yen has stabilized, currency traders believe this is temporary and are predicting more serious tests if the BoJ does nothing or makes only a cosmetic change to yield curve control after its two-day meeting on Monday and Tuesday.

Forex analysts said the Japanese government could come to terms with the idea that ¥152-¥153 is a fair level against the dollar. The widening spread between Japanese and US interest rates means the intervention is likely to be less effective than in 2022.

Comments in mid-October from the IMF, which said it saw no factors justifying intervention, reinforce markets’ belief that the ¥150 level is no longer a “line in the sand” for Japan, even as the weaker yen The BoJ’s target interest rate keeps inflation above this at 2 percent.

The central bank has argued that the main factor driving price increases in Japan is the rise in import costs and that it needs to wait for more sustained signs of wage growth to ensure the economy does not slip back into decades of deflation.

In a speech in September, Ueda noted that wage growth is starting to impact prices. Economists are paying attention to whether Ueda acknowledges a stronger correlation between wages and prices.

“Even if the BoJ doesn’t take any action this time, it won’t be surprising if it starts sending hawkish messages to prepare the public for a future rate hike,” said UBS economist Masamichi Adachi.

Japan’s core inflation fell below 3 percent in September for the first time in more than a year due to lower imported fuel prices. Adjusting for energy and fresh food prices showed that inflation also slowed to 4.2 percent from 4.3 percent in the previous month.

Still, some economists warn that above-target inflation in Japan could be more stubborn than the BoJ forecast. In October, the Japanese Trade Union Confederation said it would seek larger wage increases in next year’s negotiations. Prime Minister Fumio Kishida has also promised to raise the minimum wage from 1,000 yen an hour to 1,500 yen by the mid-2030s.

Investors around the world are closely watching Japanese bond yields as Japanese institutions are among the largest holders of American and European debt. More attractive domestic yields could trigger a wave of selling in other bond markets.

“We think the removal of the YCC could stimulate Japanese investors, but the more important driver may be if the BoJ ends negative interest rates and starts raising short-term interest rates,” said Yusuke Miyairi, an economist at Nomura.

“The level of JGB returns is still not attractive enough to repatriate their capital to Japan from overseas,” he added.

Source : www.ft.com

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