How will Japan’s interest rate decision affect Bitcoin?

Even the Central Bank’s interest rate hike announcement on Wednesday did not seem to wake the crypto money from its slumber. Perhaps the Bank of Japan (BOJ), the world’s third largest central bank, can change this.

Many investment banks expect the BOJ to ease the tightness in the country’s bond markets, which is likely to affect global bond markets, exchange rates and liquidity conditions. It is a known fact that Bitcoin and other cryptocurrencies are also sensitive to changes in global liquidity conditions.

The BOJ, which has run its yield curve control program (YCC) since September 2016, is committing to purchase all government bonds necessary to keep the 10-year government bond yield at 0 percent. As RBC Asset Management points out, continuous bond buying adds to global liquidity and puts downward pressure on bond yields in the developed world.

The bank maintained this target by allowing the 10-year government bond yield to fluctuate within a range of ± 50 basis points in December. On Friday, the bank may reduce this range to 100 basis points and reduce its bond purchases, which indirectly increase liquidity. The Goldman Sachs economics research team said in a note to clients on July 21:

According to our estimations, the first steps that can be taken may be to expand the 10-year JGB yield range or focus on the shorter maturity region. While our baseline scenario is the latter, it’s pretty hard to decide. The first option, on the other hand, may be preferred, especially for the market, since the effects of expansion are easier to predict. But assuming the BOJ maintains its 10-year target at 0 percent, extending the current ±50 basis point range to a ±100 basis point range would be the same as if the BOJ effectively stopped applying the YCC or admitted that it had lost its ability to control returns.

These possible developments may seem trivial for the bitcoin market, but this is simply not true. In the past, cryptocurrencies have seen negative correlations with bond yields, bond market volatility, dollar index and global liquidity conditions. In other words, potential changes in BOJ’s YCC policy and associated volatility in traditional markets could bring volatility to the crypto market. YCC could affect financial markets in terms of exchange rates, prevailing bond yields and global risk premiums, according to a warning from the International Monetary Fund (IMF) earlier this year.

For example, Japanese bond yields could rise sharply with possible YCC regulation, prompting Japanese investors to sell their foreign bond holdings in favor of local bonds. This raises foreign bond yields while hurting the flow of money to risk assets. Bond yields and bond prices move in opposite directions. Japan is the world’s largest lender, with a record net foreign assets of 418.63 trillion yen ($3 trillion) in 2022. Japanese investors are very interested in purchasing foreign bonds because of the low yields in the country and the relatively higher yields in other countries. Earlier this year, RBC Asset Management explained the global impact of YCC as follows:

BOJ policy could contribute to higher global yields, especially if it starts to reverse in this period when bond markets are plagued by ongoing cycles of rate hikes.