BOJ Stuck in Inflation-Fighting Quagmire as Credibility Hangs in Balance

The Bank of Japan (BOJ) is facing a severe test to its inflation-fighting credibility as structural cost pressures collide with decades of entrenched monetary accommodation.

The BOJ owns over half of all outstanding Japanese Government Bonds, giving it significant influence over the market. However, this concentration has created a situation where price discovery has vanished and liquidity dries up outside the central bank's own dealing desks.

The BOJ responded to imported inflation by widening yield curve control bands and scrapping negative interest rates. However, markets remain unimpressed, with every incremental tweak in benchmark rates triggering volatility in equity markets and mortgage pricing.

The central bank is trying to walk a tightrope over an active volcano, and the pole is made of wet cardboard. Credibility is an intangible asset that disappears with brutal speed once lost.