For years the Bank of Japan has found it easy to enforce “yield-curve control”, because the idea that it would need to raise interest rates seemed so far-fetched. From 1999 to 2012 Japan suffered bouts of deflation; for most of the rest of the 2010s inflation was positive, but well below the central bank’s 2% target. Stubbornly low inflation, and the return of deflation during the pandemic, meant that the bank looked set to stimulate the economy for ever.
Today, however, the prospect of tightening no longer seems so remote. The widening disparity between bond yields in Japan and in America has forced down the yen, which has fallen by more than a fifth against the dollar this year, to its lowest level since 1990. That has raised import costs in Japan and helped lift annual inflation to 3%.
The government has sought to prop up the yen by selling vast quantities of dollars: in September and October it got rid of over $60bn. As long as the gap between Japanese and American interest rates remains, though, such interventions are futile. And although homegrown inflation is modest—wage growth is under control and services prices are up by just 0.2% annually—resurgent inflation elsewhere cautions against assuming that it will simply dissipate. On October 28th Japan’s government announced a stimulus package to support households’ incomes as prices rise, which will only add to the upward pressure.
Some analysts predict that the Bank of Japan will adjust its yield cap in 2023, perhaps by raising it. Yet pegs are hard to move gracefully. As soon as investors expect them to be abandoned, they dump assets on the central bank in an attempt to avoid losses. The public often bears them instead. When the Bank of England abandoned a sterling peg in 1992, £3bn ($5.3bn then) went up in smoke. Already, the Bank of Japan has had to increase its bond-buying to suppress yields—a sign that the credibility of its cap could be ebbing. If one peg is ditched, investors are more likely to bet against any successor.
