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Yen pairs have been extraordinarily active these last couple of days. Implied volatility in the USDJPY rose to a six-month high. There is a lot of apprehension about what might happen at the BOJ’s interest rate decision overnight. Which is funny, because the consensus among economists and analysts is that there won’t be any change in policy.

The thing is, the BOJ has a habit of springing changes on the market. Many had become complacent about monetary policy meetings in Japan, because there hadn’t been much of a change in a long time. The BOJ had, essentially, maxed out its easing, so there was little more to do.

The world is changing

But now that the situation calls for the BOJ to start tightening – or at least, stop the extraordinary easing – then there can be policy changes. Which means the chance of a surprise increases. Everyone got a reminder of that at the last BOJ meeting, when it increased the band of its YCC, effectively allowing for more tightening of the monetary policy.

The BOJ stressed that it wasn’t actually a change in policy, because the midpoint of the target remained the same. The band was increased by the same amount above and below zero. But pressure lately has only been on the upside as Japan experiences increased inflation. Which is why in theory, it wasn’t a change in policy. But in practice, it was a move towards tightening.

What’s next

There is rampant speculation that the BOJ will further widen the YCC range, or simply do away with it altogether. This issue is timing. The consensus for the moment is that there won’t be an official change in policy until Kuroda steps down in April. Doing away with YCC would be a policy change, but as explained above, another widening of the band wouldn’t be considered a change in monetary policy.

That’s why there is a certain amount of trepidation ahead of the BOJ’s meeting. Many economic indicators point to the need for the BOJ to start tightening. But many economic indicators also suggest this will make things more difficult for Japan’s fledgling economy. The BOJ is facing a similar problem as the BOE, which is divided on how to approach the issue. Therefore, there isn’t exactly an established playbook for what the BOJ could do, unlike with other central banks, such as the Fed and ECB.

The markets really don’t like uncertainty

The theory that the BOJ operates under is that by surprising the market with changes, it has an increased effect. That way, they don’t have to make as much of a change in policy to get the result they want. But this also leaves the markets unsettled, and increases volatility, like we’ve seen over the last few days.

The thing is, recently there have been increasing challenges to the BOJ’s YCC; markets have tried to push the interest rate higher. To the point that the BOJ has had to make record JGB bonds to keep interest rates in line with targets. Which is one of the reasons fuelling speculation that the BOJ could announce another widening of the YCC after the coming meeting.

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