Japan central bank's unexpected policy change offers little succor to lenders

The Japanese central bank's unexpected revision of its yield-curve-control policy could increase the pain for the nation's lenders from their investment in local bonds.

The Bank of Japan announced Dec. 20 that it will expand its target band for 10-year bonds to 50 basis points from 25 basis points. The yield on the 10-year Japanese government bond jumped to 0.447% after the announcement, from 0.250% on Dec. 19. Shares declined and the yen spiked.

The unexpected announcement after a two-day policy meeting of the central bank shocked financial markets as most analysts had expected the Bank of Japan to keep its monetary policy steady at least until April 2023, when Governor Haruhiko Kuroda is expected to step down.

"Obviously, this is a surprise," said Makoto Kikuchi, CEO of Myojo Asset Management. Why this has happened now is a question on everyone's mind, Kikuchi said as he, like many other market participants, expected the central bank to shift away from the ultralow monetary policy only after Kuroda's exit.

Negative interest rates

The Bank of Japan under Kuroda has stayed with the negative short-term benchmark interest rate, even though inflation around the world pushed most major central banks to tighten monetary policy in 2022. The latest change in policy is possibly a precursor to policy normalization in 2023 under a new governor.

Still, the change is unlikely to provide a tailwind to Japanese banks as the policy rate remains unchanged at negative 0.1%. That means they will lose on their investment in Japanese government bonds, while lending in the economy is likely to stay muted.

However, a stronger yen will come handy as the currency has recovered somewhat from a record low reached in late-October. The latest policy decision and anticipation of higher rates will strengthen the yen further.

The Bank of Japan's action will have "little impact" on banks' lending, said Toyoki Sameshima, a senior analyst at SBI Securities Co. Kikuchi of Myojo Asset described the central bank's decision as being "ultra-negative" for banks due to the valuation loss in their government bond holdings.

Japanese banks have suffered similar pain in their investments in foreign bonds, mainly in U.S. Treasurys, hurting their capital adequacy ratios after bond prices fell with rising interest rates in the U.S. The Japanese central bank's adherence to ultralow rates so far has widened the gap between Japanese and U.S. interest rates and pushed up prices of imports, fueling inflation.