27 Sep 2016 12:10 IST

All you wanted to know about yield curve control

Central banks usually target short-term interest rates through their monetary policy

Does ‘curve control’ bring to your mind weight-loss clinics and slimming diets? Perish the thought. It is a central bank which has recently introduced the term ‘yield curve control’ to the world. Globally, central banks are vying with each other to invent new tools to revive their moribund economies. The latest one to do the rounds is ‘yield curve control’ unveiled by the Bank of Japan (BoJ) last week.

What is it?

Put simply, yield curve control is a the Bank of Japan’s attempt to keep a tight leash not only on short-term rates but also on long-term interest rates in the economy. The Bank has promised to ‘control’ the market to make sure that the yield on the country’s 10-year government bond remains at zero per cent. To achieve this feat, it will do the right amount of bond purchases. Confused?

Let us go back to basics. Central banks normally revive the activity in the economy by cutting interest rates or pumping money into the economy. When a central bank wants to infuse money into the market, it buys assets, usually government bonds, and releases cash in exchange. But when a central bank buys bonds, it also sucks out bonds from the market, thus moving bond prices up. When bond prices rise, as we know, yields on the bonds move lower. Now, the BoJ wants to ensure that that yields on the 10-year government bonds hover at zero per cent.

Why is it important?

Central banks usually target short-term interest rates in the economy through their monetary policy. In Japan, the short-term policy rate is minus 0.1 per cent. What this means is that banks in Japan will have to pay the central bank 0.1 per cent on the excess reserves they maintain with it. The intent is that banks should maximise lending.

But the BoJ now believes that controlling short-term rates alone isn’t enough. It hopes to keep tabs on long-term rates through its yield curve control. With short-term rates at -0.1 per cent and the 10-year at zero, it will ensure a steeper yield curve. This is good news for banks as they can now borrow money at cheaper short-term rates and lend at higher longer-term rates to pocket some margins.

There is yet another not-so-obvious reason for the BoJ’s move too. Currently, the yields on 10-year Japanese bonds are below zero — a negative 0.05 per cent. But yield curve control is an implicit ‘go ahead’ to the government to undertake fiscal stimulus to revive the ailing economy if need be. If the government ups spending and borrows to fund this, the supply of bonds will shoot up, prices may tumble and yields may shoot up. BoJ is saying that it will intervene in the market to ensure that the cost of borrowing for the government stays at zero.

Why should I care?

Central banks desperately trying every trick in the book to revive their economies can hardly be a comforting thought. An anemic level of economic growth, such as the one seen in Japan and Europe, has growth implications for the rest of the world — even India. Also, aggressive monetary easing has been fuelling foreign investor flows to emerging markets like India. This can create asset bubbles and leave us more vulnerable to external shocks in future. Further, how BoJ chooses to tweak its bond rates can thus influence rates in our economy as well.

The bottomline

The 7-per-cent-plus interest rate on Indian bank FDs is a great deal in this world of zero to negative rates. Lock in while the going is good.

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