July 31, 2018 / 5:40 AM / 2 months ago

UPDATE 2-JGBs rally after BOJ pledges to keep rates 'very low'

* BOJ tweaks policy to make its stimulus programme more flexible

* But it maintains pledge to keep long-term rates around zero pct

* JGB 10-year yield drops, pulls sharply away from 1-1/2-yr highs

* While market relieved, policy tweaks seen clouding YCC outlook

* Rise in JGB futures tempered after Kuroda’s comments on rates (Adds BOJ Kuroda comments, updates prices)

By Shinichi Saoshiro

TOKYO, July 31 (Reuters) - Japanese government bonds rallied on Tuesday after the central bank tweaked its monetary policy but pledged to keep interest rates low, bringing relief to a market which had braced for more radical changes to monetary policy.

Following its two-day policy board meeting, the Bank of Japan took measures to make its massive stimulus programme more flexible, reflecting its forecast that it would take time for inflation to hit its 2 percent target.

The central bank said long-term interest rates may fluctuate depending on economic and price developments and that it would conduct its bond-buying programme flexibly.

It did, however, maintain the short-term interest rate target at minus 0.1 percent and a pledge to guide 10-year government bond yields around zero percent by a 7-2 vote.

“Speculation and perhaps fear prior to the BOJ decision was that policy tweaks could include allowing interest rates to go higher. But the actual outcome showed the BOJ maintaining its short- and long-term yield targets and also its JGB buying amount under new guidance,” said Naomi Muguruma, senior market economist at Mitsubishi UFJ Morgan Stanley Securities.

“It has become clear that the tweaks does not involve policy exits or interest rate hikes. JGBs are thus being bought back as a result.”

The benchmark 10-year JGB yield fell 4 basis points to 0.060 percent.

The 10-year yield had risen steadily over the last week, reaching a 1-1/2-year high of 0.11 percent on Monday as the market braced for the BOJ potentially considering steps to make its huge monetary stimulus more sustainable.

The spike by the 10-year yield prompted the central bank to conduct three special JGB buying operations over the past six trading days to limit the yield’s rise.

The yield curve flattened on Tuesday as super long JGB yields declined sharply after the BOJ policy decision.

The 40-year yield dropped 10 basis points to 0.865 percent, its biggest one-day plunge since June 2016, to pull away from a six-month peak of 0.965 percent.

Financial markets have been abuzz with speculation after various media reports suggested the possibility of BOJ tweaking its policy.

Some had speculated the BOJ could consider adjusting its yield-curve control (YCC) scheme, which it maintains by buying large amounts of JGBs. Repeated purchases of JGBs have robbed the bond market of liquidity, and near-zero rates under YCC have strained bank lending.

Separately, the BOJ announced its debt-buying operation plan for August, leaving its buying range for all the JGB maturities unchanged from July.

POLICY TWEAKS SEEN CLOUDING YCC OUTLOOK

BOJ Governor Haruhiko Kuroda, speaking to reporters after the policy meeting, said the central bank would allow long-term yields to move up and down 0.2 percentage point each from our zero percent target to improve functions in the government bond market.

This means the BOJ may allow 10-year yields to move above 0.11 percent, which markets had considered as the bank’s line in the sand as it repeatedly stepped in to cap yields at this level thorough special JGB buying operations.

After closing Tuesday’s regular session up 0.25 point at 150.69, September 10-year JGB futures eased back in after-hours trade following BOJ Kuroda’s comments, last trading at 150.53.

Analysts suggested that the latest policy tweaks clouded the longer term outlook for YCC.

“The BOJ said it would allow long-term rates to fluctuate, and this is a key point as we can no longer pinpoint how bond-buying operations are conducted going forward,” said Noriatsu Tanji, chief bond strategist at Mizuho Securities.

“As a result of the policy tweaks, the BOJ may opt to conduct special JGB buying operations away from current levels. It could also reduce the amount of JGBs it buys at regular operations to guide yields higher.” (Additional reporting by the Tokyo markets team Editing by Joseph Radford and Sam Holmes)

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