Yen drops as BOJ sticks to ultra-easy policy, sterling hits one-month high

By Ankur Banerjee and Samuel Indyk

SINGAPORE/LONDON (Reuters) - The yen dropped against major currencies on Wednesday after the Bank of Japan maintained ultra-low interest rates, disappointing some investors who had hoped the central bank would relax its yield curve control policy further.

The central bank stunned the market last month by raising its cap on the 10-year yield to 0.5% from 0.25%, doubling the band it would permit above or below its target of zero. Since then, speculation had swirled that the BOJ could tweak its yield curve control (YCC) policy further or even scrap it.

At a two-day policy meeting, the BOJ kept intact its YCC targets, set at -0.1% for short-term interest rates and around 0% for the 10-year yield, by a unanimous vote. It also made no change to its guidance that allows the 10-year bond yield to move 50 basis points either side of its 0% target.

The yen suffered broad losses, although analysts expect tighter BOJ policy ahead and the currency trimmed earlier falls.

The dollar rose as much as 2.7% to 131.58 yen before gains were pared. It was last up 1.1% at 129.475 yen.

The euro gained 1.7% and sterling gained 1.6% to 140.65 yen and 159.85 yen, respectively. The Australian dollar jumped 1.3%.

"The BOJ was likely surprised by the reaction to its policy tweak in December which is likely why they didn't take new initiatives today," said Nordea chief analyst Niels Christensen.

"The BOJ's forecasts are expecting higher inflation, which is why we expect monetary tightening further down the road," Christensen added, although he said that would likely come when a new BOJ governor was in place in April.

Some investors have been betting the BOJ will be forced to adjust, or even dismantle, YCC on the view the central bank cannot sustain the massive volume of bond buying needed to defend the cap.

JGB YIELDS TUMBLE

On Wednesday, Japanese government bond yields tumbled the most in two decades at one point, retreating sharply from the central bank's 0.5% ceiling after the decision. The 10-year yield has repeatedly breached the ceiling in the past four sessions.[JP/T]

"The downtrend in dollar-yen is still intact," Nordea's Christensen said.

"We'll likely see a lower dollar-yen going forward but for now we might see some range trading until we get more data on the inflation outlook," Christensen added.

The dollar index, which measures the safe-haven dollar against six peers including the yen, fell 0.4% at 102.01.

Sterling rose to its highest level in more than a month even as consumer price inflation fell to a three-month low as core CPI failed to moderate, remaining at 6.3%. The pound was last up 0.4% at $1.2341.

"The small fall in CPI inflation ... and unchanged core rate ... suggests it is too early for the Bank of England to declare victory in its fight against inflation," said Capital Economics senior UK economist Ruth Gregory in a note.

"With underlying inflation, activity and wage growth all ending last year a bit stronger than expected, we doubt the Bank of England will call time on rate hikes."

Meanwhile the euro strengthened 0.6% to $1.0859 after European Central Bank member Francois Villeroy de Galhau said it was too early to speculate about what the central bank would do at the March meeting. Media reports on Tuesday said the ECB could slow its pace of tightening further in March.

The Australian dollar rose 0.4% to $0.7012, while the kiwi rose 0.7% to $0.6474, after earlier hitting its highest level in a month at $0.6489.

(Reporting by Samuel Indyk in London, Ankur Banerjee in Singapore; Editing by Kim Coghill, Raissa Kasolowsky and Alex Richardson)