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How Donald Trump’s win could make the Bank of Japan’s job harder

Donald Trump might have just complicated the Bank of Japan's abortive efforts to spur inflation.

The global rout in bond markets that accompanied Trump's surprise win has also spilled over to Japan where the central bank radically shifted its policy framework at its late-September meeting, making yield-curve control its centrepiece, rather than its already negative benchmark interest rate.

The BOJ said it would buy 10-year Japanese government bonds (JGBs) so that the yield would hover around zero percent, while keeping a lid on short-term rates. The deposit rate was left unchanged at negative 0.1 percent.

Sticking with the yield target hadn't been too difficult until recently: The 10-year JGB yield had largely remained slightly negative since the BOJ's surprise decision in late January to introduce its negative interest-rate policy.

That's helped ease another concern: That the central bank, which already owns more than a third of all JGBs, would run out of bonds to buy as it continued with its planned 80 trillion yen (around $735.27 billion) annual pace of expansion of its monetary base.

But that calm has been challenged by the slide in major global bond markets in recent days. Bond prices move inversely to yields.

U.S. Treasurys sold off on bets Trump's plans to goose the economy through fiscal stimulus would increase the budget deficit and fan inflation. The yield on the benchmark 10-year note rose to its highest level since late December. The benchmark yield touched levels above 2.3 percent in the U.S. earlier this week, up from levels below 1.8 percent in the days before the election. On Thursday, it was around 2.20 percent.

That also spurred selling in Japan's bonds, with the 10-year JGB climbing into positive territory this week, rising from as low as negative 0.083 percent on November 9, as U.S. election results were coming in, to as high as positive 0.031 percent on Wednesday, the highest since February, according to Reuters data.

To be sure, that's not a grand jump in the larger market scheme.

Marcel Thieliant, a Japan economist at Capital Economics, said on Wednesday, that the rise likely was still within the BOJ's yield target. But the central bank was also likely remaining vigilant.

"We've previously argued the bank will have to reduce purchases over the coming year," he said. "If yields in the U.S. continue rising as we expect, they might have to stick with the current pace [of purchases] a bit longer."

The BOJ may have been feeling some pressure: On Thursday morning, it offered a special fixed-rate buying operation of JGBs with one to three years to maturity at a yield of 0.020 percentage point above the previous close and at 0.019 percentage point above the previous close for JGBs with three to five years to maturity, Reuters reported. That may have helped boost prices for the 10-year JGB on Thursday, with the benchmark bond's yield opening at 0.026 percent before falling to 0.014 percent by 9:30 a.m. HK/SIN, according to Reuters data.

While higher yields in Japan would have a tightening effect, Thieliant noted that the BOJ has some breathing room before it might need to add further easing because the market ructions after the election surprise have also sent the yen lower. The dollar had risen to within a whisker of 110 yen on Wednesday from levels below 105 in the election lead up.

That could reassure the BOJ as it struggles to meet its new goal of exceeding its long-unreached target of 2 percent inflation.

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While the BOJ has claimed Japan's economy has been booted out of a decades-long deflationary spiral, the central bank has had limited success in generating the desired levels of inflation. In September, Japan's consumer price index fell 0.5 percent on-year, unchanged from August, although it rose on-month, according to official data.

But analysts noted the BOJ may have painted itself into a corner.

Its twin goals of targeting a zero-yielding 10-year bond and continuing its pace of asset purchases are "incompatible," Societe Generale said in a note on Wednesday.

"If long-term interest rates continue to rise globally, upward pressure on JGB yields is likely to rise as well," it said, adding that means the BOJ would either need to "substantially" boost its bond purchases, or if it can't," raise the yield target.

"This would, of course, mark a tightening of monetary policy, and it would not be brought about because domestic economic conditions warrant such a step," Societe Generale said. "At this stage, it is entirely unclear how monetary policy in Japan would deal with such a situation."

Japan's gross domestic product (GDP) growth beat expectations for the July-to-September period, rising an annualized 2.2 percent, compared with a Reuters poll forecast of 0.9 percent. But analysts attributed that to exports, with consumption remaining weak and signs that the service sector was slowing.

That's not a situation where most global central banks would countenance any tightening of policy.

Bank of Japan's Governor Haruhiko Kuroda may agree: On Thursday morning, he said the BOJ wouldn't have to accept higher JGB yields just because U.S. Treasury yields are rising, according to a Reuters report. Kuroda also said the central bank could raise or lower its 10-year yield target as the economic situation warranted, the report said.

Some don't expect any rise in JGB yields to last long, even without BOJ action.

"We see a positive 10-year yield as a buying opportunity," Deutsche Bank said in a note on Wednesday, adding it expected the yield would only stay positive for a few weeks.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1

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