By Leika Kihara
TOKYO (Reuters) -The Bank of Japan could help prevent abrupt policy changes later by allowing more flexibility in its bond yield curve control, the International Monetary Fund said in its global financial stability report released on Tuesday.
Under yield curve control (YCC), the BOJ guides the 10-year government bond yield around 0% as part of efforts to sustainably achieve its 2% inflation target.
The central bank's decision in December to widen the tolerance band around the yield target has heightened market bets of a further near-term tweak or end to YCC.
Changes to the BOJ's yield control policy may affect financial markets through exchange rates, term premiums on sovereign bonds and global risk premiums, the IMF said.
"While allowing more flexibility in the yield curve control policy could have some repercussions in global financial markets, such a change not only is warranted to meet monetary policy objectives but could also help prevent abrupt policy changes later that could trigger larger spillovers," the IMF said in the report.
The BOJ has kept policy ultra-loose even as other major economies hiked interest rates to combat soaring inflation, on the view the recent cost-driven price growth won't be sustained unless accompanied by stronger economic and wage growth.
While the yield control policy has helped keep borrowing costs low, it has come under increasing criticism for distorting market pricing and crushing financial institutions' profits.
The BOJ's new governor, Kazuo Ueda, stressed on Monday his resolve to keep ultra-low interest rates for now, brushing aside lingering market expectations of a near-term policy shift.
In the report's section analysing the potential impact of a tweak to YCC, the IMF said a further rise in Japanese long-term interest rates could affect bond yields of Australia, several euro-area countries and the United States as Japanese investors repatriate the huge amount of funds parked in these markets.
Some emerging markets like Indonesia and Malaysia could also face "material" capital outflows due to the significant presence of Japanese investors, it said.
"The pace and possible effects of repatriation could be larger, however, should market participants be surprised by the Bank of Japan's announcements and actions," the report said.
"Clear communication in the event of adjustments to the Bank of Japan's monetary policy is critical to avoid market volatility," it said.