With a “very significant uncertainty” around the inflation outlook in Japan, the country’s central bank should consider augmenting flexibility in longer term yields, the International Monetary Fund recommended Thursday in an Article IV report.

“The policy challenge in the near term is to ensure that the 2% inflation target is reached durably, without overshooting significantly,” the IMF said. Japan’s inflation rate accelerated 4.0% in December 2022 from a year before, marking the highest reading since Jan. 1991.

To better manage upside inflation risks amid the yen’s depreciation, the fund suggested the Bank of Japan — known for its decade-long monetary easing stance — to increase the 10-year yield target, widen the 10-year yield target band, shorten the yield curve target, or pivot back to a quantity objective for bond purchases.

If the BoJ widens the yield range, which was completed last month for 10-year JGBs, “the fluctuation range will have to be wide enough for market forces to play a leading role,” the IMF noted. If it adopts a quantity target, the BoJ will have to be prepared to buy bonds in the event yields spike. And shifting to a shorter-term yield target could result in costly side-effects.

Overall, “more flexibility in long-term yields would help to avoid abrupt changes later. This would help better manage inflation risks and also help address the side-effects of prolonged easing,” the report said. “In the scenario that significant upside inflation risks materialize, monetary stimulus withdrawal will have to be much stronger — short-term rates may have to rise much earlier and above the neutral rate to anchor inflation back towards its 2% target.”

The IMF sees inflation, excluding fresh food prices, sliding back to under 2% by the end of 2024 after peaking in Q1 2023, as higher import prices start to reduce cost increases.

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Earlier, the BoJ announced no changes to shorter term rates.