Japan takes another step away from easy money | ET REALITY

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The people pulling the levers of Japan’s economy are in a bind: The country’s low interest rates, which they have long used to fuel growth, are now far out of step with those of other major economies. Closing that gap is complicated.

The yen is at a near-record low against the US dollar, threatening to inflict prolonged inflation on Japan, which for years suffered from the opposite problem. But if authorities in Tokyo loosen their grip too much and rates rise too high, they could impose higher borrowing costs on Japan’s businesses and consumers and wreak havoc on financial markets.

On Tuesday, the central bank, the Bank of Japan, attempted to thread the needle, announcing a policy that aims to push bond yields higher. The bank said would use 1 percent as a starting point for 10-year government bond yields, rather than a cap, saying it expected inflation to rise more than it had previously thought. In July, he had announced that he would allow those yields to fall above 0.5 percent, which had been the bank’s ceiling.

The decisions of the Bank of Japan, headed by Governor Kazuo Ueda, have repercussions throughout the world, especially in US markets. Interest rates in the United States are well above those in Japan: 10-year U.S. Treasury yields briefly topped 5 percent in September, a level not seen since 2007.

Rates in the United States have risen since the Federal Reserve, the US central bank, began a sustained effort to control inflation caused by an economic resurgence after the coronavirus pandemic. The Federal Reserve on Wednesday is expected to hold steady with rates already at their highest level in 22 years.

With rates so high, Japanese investors (and many others) have bought Treasuries to take advantage of them. Japan is the largest foreign holder of US public debt, according to official federal data.

Government bond interest rates are used as a benchmark for many other types of debt, including mortgages, credit cards, and business loans. The cost of borrowing helps determine the growth of an economy.

Central banks are the gatekeepers. They move interest rates up and down primarily by selling and buying government bonds. Buying bonds increases their value or price and reduces their yield or payment. Selling them decreases their value by putting more on the market; When their prices go down, their returns go up.

By hoarding US Treasuries, Japanese investors have increased demand for dollars and contributed to the decline of the yen. As a result, the Bank of Japan has been forced this year to prop up the yen while also trying to keep interest rates low.

By allowing yields on its government bonds to rise, the Bank of Japan is restoring some of the attractiveness of its domestic debt, hoping that will boost demand and strengthen the yen, at the expense of the dollar. The United States is the world’s largest economy and Japan the third, and its currencies are among the most traded.

Stefan Angrick, senior economist at Moody’s Analytics in Tokyo, said the Bank of Japan has been “moving in the direction” of allowing yields to rise over the past year. “The bank is clearly uncomfortable with the weak yen,” he added.

Last week, the yen fell to its weakest level against the dollar since October 2022, then rebounded on Monday as rumors emerged about a possible change in Bank of Japan policy. The yen initially weakened following Tuesday’s announcement.

The central bank’s move comes at a crucial time in global markets. Geopolitical instability (wars in Europe and the Middle East and protectionist-oriented trade policies by the world’s major economies) has increased nervousness about the possibility that a sudden rise in US government bond yields, which underpin the borrowing costs for consumers and businesses around the world, could threaten the resilience of the economy.

The Bank of Japan’s decision could amplify some of those fears in the United States, especially if it leads to a notable shift in demand for Treasuries among Japanese investors, which could push U.S. yields even higher.

Ben Dooley contributed with reports.

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