Bank of Japan shocks markets with surprising policy switch

(Alliance News) - Japan's central bank tweaked its longstanding monetary easing programme on Tuesday, in a surprise move that saw the yen strengthen against the dollar and stocks in Tokyo sink.

The change marks a rare shift of gears for the dovish central bank, which has largely left its policy intact even as counterparts in other major economies hike rates to tackle inflation.

The dollar was trading at JPY131.27 at the London equities close on Tuesday, significantly lower compared to JPY137.00 at the same time on Monday. Meanwhile, in Tokyo, the Nikkei 225 finished 2.5% lower.

After a two-day policy meeting, the bank said it would widen the band in which it would allow rates for 10-year Japan government bonds to move, saying it would "improve market functioning".

"The Bank will expand the range of 10-year JGB yield fluctuations from the target level: from between around plus and minus 0.25 percentage points to between around plus and minus 0.5 percentage points," it said in a statement.

Few had anticipated the shift, with all 47 of the economists surveyed by Bloomberg ahead of the decision saying they expected no change in policy.

The bank left the rest of its longstanding loose monetary programme intact, including its years-old inflation target of two percent.

For a long time, the Bank of Japan has been viewed as an outsider among global central banks, with ING's Francesco Pesole dubbing the Japanese bank "an ultra-dovish outlier" responsible for the weakness of the Japanese yen in 2022.

However, following today's announcement, Pesole suggested this may be the first step towards a broader policy normalisation process in Japan, which may "quite radically" change the outlook for the yen in 2023.

Analysts at Brown Brothers Harriman, however, said they continued to believe that the fundamental outlook favours the dollar, though they admitted that the BoJ has "thrown a spanner in the works".

"While the announcements don't, per se, represent an actual resetting of the central bank's policies they signal an intention to create an exit strategy from the ultra-accommodative approach that has characterized the BoJ's stance over the last few years," explained Ricardo Evangelista at ActivTrades.

CMC Markets' Michael Hewson added that the shift from the Bank of Japan also suggests that the central bank is becoming concern about "policy lags and inflation becoming more entrenched."

Hewson also argued that the move gives the Japanese central bank more flexibility in 2023, in the event they need to "start applying the brakes" to prevent a "significant overshoot" in inflation. He suggested that markets may even see a rate hike "before the end of next year."

Edward Moya of Oanda said that the odds for a rate hike from the bank at its January meeting were now at 22.3%.

By Heather Rydings, Alliance News senior economics reporter

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