The conflict between Japan’s government and its central bank has taken a new twist. In January, the Bank of Japan finally accepted a 2 per cent inflation target and committed to open-ended asset purchases. Had the BoJ refused the inflation target, the government of Shinzo Abe would likely have proposed changes to the BoJ Law, thus removing, or reducing, the bank’s independence.

This battle between government and central bank is nothing new. What is worth noting, however, is that this time, the market has sided with the government. The Japanese yen has weakened and stock prices have risen. While Masaaki Shirakawa, the BoJ governor, warned that a loss of credibility in government policy could sharply increase the interest rates on Japanese government bonds, the sovereign bond market has remained relatively calm, at least so far. “Abenomics” appears to have won.

The key to understanding the success of Abenomics is the asymmetric response between the currency and the bond markets, which can be attributable to divergent inflation expectations. In the currency market, inflationary expectations rose among investors, mostly non-Japanese, while on the other hand the JGB market remains dominated by Japanese investors, whose inflation expectations appear more or less unchanged.