"Such effects are expected to be mitigated by conducting yield curve control with greater flexibility,” - Bank of Japan.

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The Pound to Yen exchange rate was the biggest faller among Sterling pairs early in the final session of the week after the Bank of Japan (BoJ) said it would enhance the sustainability of its Yield Curve Control program by being more flexible about the level government bond yields are allowed to rise to.

Japan's Yen rose widely to outperform all other major currencies in early European trade on Friday after the BoJ said it would buy 10-year government bonds at a one percent yield each day unless it appears highly likely that no bids will be submitted at an auction.

"The Bank judges that sustainable and stable achievement of the price stability target of 2 percent has not yet come in sight, and thus patiently continues with monetary easing," the bank said in an explainer.

"With extremely high uncertainties for economic activity and prices, the Bank enhances the sustainability of monetary easing by conducting YCC with greater flexibility," it added.

The change was preceded by reports suggesting a discussion of it could be likely at Friday's meeting, leading the 10-year bond yield to rise above the previous 0.5% upper limit prior to the announcement and prompting a rally by the Yen.

Above: Japanese Yen relative to G10 and G20 currencies.

The BoJ had already discussed the "treatment" of the Yield Curve Control program back in June due to high costs of enforcing the yield cap in the face of rising interest rates elsewhere in the world previously, while the twek comes early in a formal review of the broader monetary framework announced by new Governor Kazuo Ueda in April.

"If upward movements in prices continue, the effects of monetary easing will strengthen through a decline in real interest rates, while on the other hand, strictly capping long-term interest rates could affect the functioning of bond markets and the volatility in other financial markets, the BoJ said in Friday's monetary policy statement.

"Such effects are expected to be mitigated by conducting yield curve control with greater flexibility. Meanwhile, there are also significant downside risks to Japan's economic activity and prices, including the impact of a tightening of global financial conditions on overseas economies," the bank also said.

The Bank of Japan interest rate was, meanwhile, left unchanged at -0.1% on Friday while the bank said nothing to suggest it would follow up its latest move with further adjustments but rather indicated otherwise through the above remarks and cuts to its forecast for inflation over the coming years.

The bank lifted its 2023 forecast from 1.8% to 2.5% on Friday while also raising its projection for the core inflation rate, which is seen as a better reflection of domestic inflation pressures for its exclusion of energy and food items from the goods basket, from 2.5% to 3.2%.

Source: Bank of Japan.

"The YCC tweak doesn't come as too much of a surprise, reflecting the backdrop of relatively strong inflation, ongoing fiscal support, an uber cheap JPY, and political concerns around the negative cost of living impact of higher inflation," says Alex Loo, an FX and macro strategist at TD Securities.

"For one thing, Japan's inflation data trends are the strongest across all the countries we track. The bond market has also been functioning more smoothly. Yet, at the same time, the upward inflation revision for FY2023 made the old policy look stale, reflecting an implied drop in the real yield curve," he adds.

Prior to the decision the Statistics Bureau said inflation had fallen from 3.2% to 3% in Tokyo during July, overshooting an economist consensus that had looked for a fall to 2.9% but doing little to challenge the BoJ's forecast outlook.

"Regarding the outlook, even as actual inflation decelerates, inflation expectations are likely to rise moderately toward the end of the projection period, with improvement in the output gap and changes in firms' wage- and price-setting behavior and in labor-management wage negotiations," the BoJ said on Friday.

"This will likely lead to a sustained rise in prices accompanied by wage increases," it added.

Above: Pound to Yen rate shown at daily intervals with USD/JPY and EUR/JPY. Click image for closer inspection.