On Tuesday, the Bank of Japan made only minor adjustments to the YCC policy at its latest policy meeting, highlighting its dovish base that is hard to change and faces many constraints in its turn.

Governor Kazuo Ueda, in the dilemma between "foreign exchange protection" and "bond protection", finally chose "bond abandonment" and announced that the 1% ceiling of JGB yield was changed from "hard boundary" to "reference point". Currency markets, already under pressure, responded: the yen suffered its biggest one-day fall against the dollar since April as the Bank of Japan's move on the YCC was less aggressive than expected. The yen fell 1.7 per cent overnight to 151.60, taking it to its lowest level since October and once again approaching the mark marked by the Bank of Japan's last actual intervention in the currency market.

The yen is the worst performing major currency so far this year, down more than 13 per cent against the dollar.

Some, including UBS, had predicted ahead of the meeting that the BOJ would take more aggressive measures to narrow the interest rate gap between Japan and the US - that is, to remove controls on the yield curve. But neither the weak yen nor persistently above-target inflation has convinced the boj to abandon its ultra-loose policy.

JGB, JPY two choice one, Ueda and male chose the bond

Since last year, Japan has been facing a policy "impossible triangle" (when a country's policy choices in an open economy cannot simultaneously achieve free capital movement, monetary policy independence and exchange rate stability).

The boj still faces a dilemma between keeping interest rates low to stimulate the economy and wage-based inflation while maintaining a stable exchange rate to prevent imported inflation from eroding domestic purchasing power and slowing the domestic recovery. So the boj faces a choice between maintaining monetary policy independence or stabilizing the exchange rate.

The Bank of Japan has clearly chosen the former. In the JGB market, various international investors "bet" against the Bank of Japan, trying to short JGBS, while the boj continues to struggle with quantitative easing and resolutely defend the 10-year yield ceiling target, even at the cost of a sharp depreciation in the exchange rate.

For analysts, the boj's insistence on holding on to the bond market can be seen as a quest for monetary-policy independence: If yields were allowed to rise sharply, funding costs would rise sharply not only for the government but also for the private sector, potentially undoing the BOJ's efforts over the past decade to maintain quantitative easing to stimulate the economy:

On the one hand, Japan finances its economy by issuing massive amounts of government bonds every year, which currently account for more than 250% of GDP. A sharp rise in 10-year yields would raise the government's funding costs; At the same time, because the Bank of Japan has a large number of government bond assets, the rise in government bond yields and the fall in bond prices will also cause the Bank of Japan's assets to "shrink".

On the other hand, the 10-year bond yield is seen as the risk-free rate, and higher interest rates will also increase the cost of financing for the private sector, which is bad for the development of Japanese companies.

In addition, once the yield of government bonds is "lost", it may cause the risk of "double kill" for Japan. This year, despite the sharp depreciation of the yen, Japanese financial markets have remained stable, and the Nikkei 225 has been the biggest gainer among major stock indexes, a big reason is the support of easy liquidity.

Intervention alone? It's hard to stop the yen's slide

Analysts predict that if the yen continues to weaken to 32-year lows, Japanese finance Ministry officials are ready to intervene and support the yen again, possibly at a level between 152 and 155 yen.

Chris Turner, global head of markets at ING, told the media:

"The BOJ is probably quite happy with where JGB yields are and relies on intervention to prevent the yen from getting out of control."

Bank of America has previously noted that until U.S. interest rate volatility abates, Japanese policymakers will have to use foreign exchange intervention and additional bond purchases to ease weakness in the yen and JGBS, operations that could send a mixed signal to the market. Meanwhile, shorting JGBS and the yen against the dollar will continue to be the way to trade in the Japanese market for the rest of 2023.

However, intervention alone cannot sustain the yen's decline, and whether the yen can stop falling depends largely on a shift in monetary policy by the Federal Reserve, which pulls down the dollar and pushes up the yen.

The falling yen already poses a potential risk for the Bank of Japan, as it pushes up the cost of imported goods and could worsen inflation, undermining the bank's 2% inflation target.

Eva Sun-Wai, fund manager at M&G Investments, said:

"The Bank of Japan is trying to support the currency without being seen as tightening policy. "If they let yields go much higher and the BOJ has so much debt, there is a risk that they won't be able to refinance at higher rates."

However, investors believe that with the economy still strong and inflation persistently above target, the BOJ will inevitably normalise policy.

Iain Stealey, jpmorgan's international chief investment officer for fixed income, told reporters:

"We expect the BOJ to take a more aggressive stance going forward, possibly ending negative interest rates...... It will be finished next spring at the earliest.