The Japanese flag flutters over the Bank of Japan head office building (bottom) in Tokyo on April 27, 2022. (KAZUHIRO / AFP)

TOKYO – The Bank of Japan decided on Tuesday to allow long-term interest rates to rise more by widening the band around its yield cap, in a surprise move to address the rising cost of prolonged monetary easing.

But the central bank kept its yield target unchanged and said it will sharply increase bond buying, a sign the move was a fine-tuning of its existing ultra-loose monetary policy rather than a withdrawal of stimulus.

"The BOJ decided to modify the conduct of yield curve control to improve market functioning and encourage a smoother formation of the entire yield curve, it said in a statement.

"Through these steps, the BOJ will aim to achieve its price target by enhancing the sustainability of monetary easing under this framework," it said.

The benchmark Nikkei share average slumped 2.35 percent and the 10-year bond yield spiked to 0.455 percent after the decision, while the dollar fell 2.7 percent to a four-month low of 133.11 yen

As widely expected, the BOJ kept unchanged its yield curve control targets, set at -0.1 percent for short-term interest rates and around zero for the 10-year bond yield, at a two-day policy meeting that ended on Tuesday.

But it decided to allow the 10-year bond yield to move up and down 50 basis points around the 0 percent target, wider than the previous 25 point band.

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The benchmark Nikkei share average slumped 2.35 percent and the 10-year bond yield spiked to 0.455 percent after the decision, while the dollar fell 2.7 percent to a four-month low of 133.11 yen.

"They've widened the band, and I guess that came earlier than expected. It raises questions as to whether this is a precursor of more to come, in terms of policy normalization," said Moh Siong Sim, currency strategist at Bank of Singapore.

"The writing's on the wall that perhaps the sharp yen weakness that we've seen previously was uncomfortable for policymakers…it's clear that it adds to the yen strength story next year."

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BOJ Governor Haruhiko Kuroda is expected to hold a news conference at 3:30 pm (0630GMT) to explain the decision.

Kuroda has repeatedly said he saw no need for the BOJ to tweak yield curve control, including taking immediate steps to address the side-effects such as the distortion it was creating in the bond market.