Japan's yield curve control and interest rates

All eyes are on Japan today for two reasons - incoming BOJ governor Ueda's first parliamentary hearing and Japan's yoy inflation report.

What's going on in japan with their ultra-low interest rates?
Japan's yield curve control (YCC) policy from 2016 was introduced to keep interest rates low and stable by intervening through buying and selling Japanese government bonds (JGB). This was to prop up the economy after years of sluggish growth by lowering the cost of borrowing to boost investments and spending. Its target for the 10-year JGB yield was 0% but it recently increased its cap to 0.50% after coming under attack from other markets speculating about an upcoming interest rate hike in the face of its highest inflation in the last 40 years.

Significance of Japan in the global markets
Japan has been the world's largest creditor for more than 3 decades, with more than $3t of net investments overseas (Reuters). In particular, Japanese investors hold a significant amount of foreign debt with about 50% in US assets and about 30% in eurozone securities. Last year, Japanese investors have already started to sell their US and Euro bonds because of increasing interest rates. If the BOJ decides to raise the bounds of the 10-year JGB yield, we might see more capital inflows from these sources back into Japan (an outflow from global markets could mean a crash). Furthermore, if the 10-year yields of the bonds from the world's largest creditor are raised, global borrowing costs will rise.

Current inflation backdrop
Japan is experiencing its highest inflation in 40 years at 4%, double the BOJ's 2% target (update: it is now at a 41-year high of 4.2%). Wholesale prices are up 9.5% yoy, putting pressure on the BOJ to give more slack to its YCC policy and cut back on its stimulus programme (Reuters). 

Japan's newly nominated governor
Ueda is expected to steer japan away from its ultra-loose monetary policy, but analysts expect this will not happen anytime soon - probably mid-2024 (CNBC). In his hearing, he mentioned that current low interest rates are appropriate, and BOJ would raise interest rates instead of selling its bonds if it was to phase out its stimulus programme. 

My thoughts on Japan's rates
The high inflation in Japan is unlikely to continue. Despite Japan's low unemployment rate of 2.50%, its workforce is decreasing and productivity has not been increasing over the long run. Manufacturing PMI has been decreasing over the last year, and retail sales are not particularly strong. One thing that prevents this is the weak yen which puts upward pressure on producer prices and imports. To ensure sustainable economic growth, Japan will need to look at increasing its labour force and productivity levels to increase its output and potential GDP. Its current low interest rates stimulus is expensive and unlikely to sustain its growth without growing labour and productivity, and while inflation is at a multi-decade high, it is still one of the lowest among other developed economies like the US and EU. Japan's rates may then depend on which is more pressing - economic growth or ability and willingness to defend its central bank against speculative attacks. Or, it may also be an in-between: phasing out stimulus but spurring economic growth through other means, such as reducing interest rates on financial institutions' reserves held by BOJ like Ueda mentioned. In the short term, the yield is unlikely to change by much, and any phasing out of the stimulus will probably only take place in the latter half of this year or next year. Yen might be a good-to-hold, but Japanese equities might take a hit from the increased input prices which will hurt its bottom line. JGB is also not as attractive in the face of the potential rate increase.