On Friday, the Bank of Japan (BoJ) announced a policy shift, marking its first major change since Kazuo Ueda assumed the role of Governor in April. The central bank loosened its yield curve control, aiming to address concerns about the prolonged impact of its monetary easing on financial markets and the real economy. The decision shocked the global financial world as many experts viewed the move as the start of BoJ’s future policy normalization.

Expanded Yield Curve Control

The BoJ's recent policy will now allow 10-year Japanese government bond (JGB) yields to fluctuate around the 0% target level within a range of approximately plus and minus 0.5 percentage points. However, the central bank decided to increase its tolerance level by 50 basis points, offering to purchase 10-year JGBs at 1% through fixed-rate operations. This move signifies greater flexibility in managing the yield curve.

Investors should note that the BoJ had introduced a fresh set of changes to its ongoing policies in the September 2016 meeting. The key change then was that the bank would control the bond yield curve. It would issue a zero interest-rate target for 10-year government bonds to counter deflationary threats and accordingly buy bonds. Markets termed Japanese measures as QQEYCC.

Inflation Forecast Raised

The BoJ raised its median forecast for inflation to 2.5% for fiscal 2023, up from the previous prediction of 1.8% in April. With the surge in commodity prices last year, the BOJ was required to defend its yield limit with more bond purchases. This led to talks in the market that the Japan’s central bank was twisting the pricing mechanism in the market, which led to yen weakness that in turn inflated the cost of raw materials imports even further.

Hence, the BoJ took the latest step to counter "extremely high uncertainties for Japan's economic activity and prices."This approach will allow BoJ to deliver prompt responses to likely risks and challenges, ensuring a more agile monetary policy.

Market Reaction

The BoJ's policy announcement triggered a sell-off in 10-year JGBs, leading to their highest yields since September 2014, per CNBC. The Japanese yen experienced volatility against the dollar, post BoJ’s announcement.Japanese bank shares, including Mitsubishi UFJ, rallied in Tokyo. Equity market, though initially faltered, recovered losses afterward.

BoJ is Still Dovish

BoJ chief Ueda said “letting yields move completely freely would essentially be abandoning YCC, and we’re not ready for that.” “We’d like to adjust the speed of yield moves and prevent speculative bond trading from spreading,” as quoted on CNBC. It means the latest move is just a policy tweak and BoJ hasn’t shifted from its dovish stance yet.

ETFs in Focus

The move is likely to benefit Invesco CurrencyShares Japanese Yen Trust (FXY Quick QuoteFXY - Free Report) . The Japanese Yen is the national currency of Japan and the currency of the accounts of the Bank of Japan, the Japanese central bank. The fund has a Zacks Rank #2 (Buy). The fund is off 7.4% this year, which means that the fund is available at a cheaper valuation.

Japan ETFs are still cheap. And hence, investors can play Franklin FTSE Japan Hedged ETF (FLJH Quick QuoteFLJH - Free Report) , iShares MSCI Japan Small Cap ETF (SCJ Quick QuoteSCJ - Free Report) , iShares MSCI Japan Value ETF (EWJV Quick QuoteEWJV - Free Report) , WisdomTree Japan Hedged SmallCap Equity Fund (DXJS Quick QuoteDXJS - Free Report) . In face of a stronger yen, small-cap Japan stocks should do better than export-oriented large-cap stocks. Plus, value stocks are also better bets amid a rising rate environment.