Bank of Japan's ‘Technical' Policy Change Is Anything But

The messy compromise can't mask the obvious, which is that central banks are retreating from long-held policies of manipulating yields lower.

Bank of Japan's ‘Technical' Policy Change Is Anything But

The Bank of Japan's surprise decision to increase the upper bound of its target for 10-year Japanese government bond yields to 0.5% from 0.25% was presented as another case of Governor Haruhiko Kuroda, who has been in the post for almost a decade, catching the market off guard. He presented the change in almost entirely technical terms. The central bank thinks inflation rates will go down again, so it wasn't abandoning a policy of yield-curve control, Kuroda said.

All the move is designed to do is improve the functioning of the fixed-income market. Indeed, there are days when 10-year bonds don't trade at all.Quite how this would happen is unclear. It announced at the same time that the BOJ would increase purchases of so-called JGBs from 7.3 trillion yen ($55.2 billion) to 9 trillion yen, which would seem more likely to sap liquidity further.

Still, I really don't know what these numbers mean. After all, a central bank can't simultaneously pursue price and quantity targets.In any case, this is all nonsense and a classic case of the difference between what the Japanese call honne and tatemae, or reality and appearance. In reality, Kuroda is due to retire on April 8, 2023 at the latest.

The betting inside the BOJ is that he will be replaced by Hiroshi Nakaso, a former deputy governor of the central bank and current chairman of the Daiwa Research Institute. I suspect his arrival will be warmly welcomed at the BOJ. I've known him for 25 years and he is strongly opposed to yield-curve control.

Nakaso published a book last year about how the BOJ should stop controlling the long end of the bond market and concentrate only on short-term rates. He will also gradually shrink the BOJ's huge balance sheet. At 127% of gross domestic product, it is far bigger than any other central bank.That makes the latest policy announcement a messy compromise in a transition brokered, apparently, by Prime Minister Fumio Kishida.

The finance ministry didn't want any change in long-term interest rates and why would it? The compromise was for the BOJ to announce more QE at the same time, even though it makes no sense. The bigger point is that all this is merely a fig leaf for a BOJ under a new governor that will pursue a radically different monetary policy. Since markets knew that both Nakaso and the other candidate who had been in the running for governor, current BOJ deputy governor Masayoshi Amamiya, are more hawkish, keeping the yield target at 0.25% would have been increasingly untenable as Kuroda's retirement date approached.

Now we know, it is completely untenable.It is hard to overemphasize the importance of this policy change. Starved of yield domestically and with the yen on a vicious weakening trend, Japanese investors have turned to bond markets elsewhere where yields are higher. Although offering slightly more yield on JGBs is insufficient in itself to make domestic bonds more attractive, this change in policy is likely to make the yen much less of a one-way bet.

As it is, the yen has strengthened the past couple of months, eroding the extra returns offered by US Treasuries and, to a lesser extent, European bonds.The broader context here is that one-by-one the world's biggest central banks are reversing long-held policies of manipulating bond yields lower. The BOJ's move is just the latest but probably the most significant given how long it has been suppressing market yields. This is another way of saying that one arm of governments (central banks) isn't manipulating as much the rate at which the other arm of the governments (their treasuries) was willing to borrow.

Guess what happens when bond investors are given more choice? Yields rise. Japanese yields have a lot more room to rise. I doubt the BOJ's new target will be credible given that it has scrapped its old target and will soon be under new management.

Given current inflation rates, no one in their right mind would lend to the Japanese government at these yields.Or, for that matter, the derisory yields available in most of Europe. Last week, the European Central Bank announced that it will start shrinking its balance sheet by 15 billion euros ($15.9 billion) a month from March. At some point, the BOJ will do the same.

As it is, the combined balance sheets of the ECB, BOJ and Federal Reserve are already contracting at rare of 10% annually, according to Yardeni Research. So, the central bank bid for bonds will increasingly go into reverse, as they will be selling into the market. And they will be doing so at a time when the supply from governments is about to go up markedly.

Yields will rise and risky assets will remain under pressure. That's a main takeaway from the BOJ's 'technical' change. More From Bloomberg Opinion:• Master of Surprise Kuroda Does It One More Time: Reidy & Moss• Bank of Japan Decision Will Affect the World: Marcus Ashworth• Investors Would Be Better Off Believing the Fed: Bill DudleyThis column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.Richard Cookson was head of research and fund manager at Rubicon Fund Management. Previously, he was chief investment officer at Citi Private Bank and head of asset-allocation research at HSBC.More stories like this are available on