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Japan monetary policy: wait and see

As expected, the Bank of Japan (BOJ) decided to leave its key interest rate at 0%-0.1% at its last meeting on Friday. Only few market participants had expected a change. After the meeting, BOJ Governor Kazuo Ueda left open the possibility of a rate increase. “It is absolutely possible to decide on a rate hike (in July), depending on the data and information on the economic and price situation that will be available by then,” Ueda said.

At the same time, the Japanese central bank announced their intention to buy fewer government bonds in future, without being concrete. “When reductions happen, it will be a sizable amount,” Ueda said.

“The Bank of Japan has disappointed the market again with a vague announcement to reduce its purchases by an unspecified amount at an unspecified point in time. The market will have to wait until the July meeting to hear more,” said Chris Turner, Global Head of Markets at ING.

“If there were big reductions, it would send bond yields higher, which in turn would give a boost to the Japanese yen,” Nikkei Asia quoted Hideo Kumano, chief economist at the Dai-ichi Life Research Institute.

The yen has lost over a third of its value since 2022. The currency’s weakness is pushing import prices higher which is increasingly concerning Japanese corporations, a survey by Economy Watchers in Japan found, as it reduces their profit margins.

“Historically, Japan’s ultra-low interest rates have underpinned its monetary policy aimed at stimulating economic growth and curbing deflation. However, the recent yen depreciation and corresponding rise in import prices are fostering arguments for the BoJ to consider raising interest rates,” wrote Gaël Fichan, Head Fixed Income at SYZ Group, in May. “While higher rates could attract yield-seeking capital flows and thereby strengthen the yen, they could also suppress domestic economic growth by increasing borrowing costs.”

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The outlook for the Japanese economy looks clouded. The gross domestic product (GDP) contracted an annualized 1.8% in the first three months of 2024 compared to the previous quarter.

“Wage growth looks set to remain robust based on the latest tally of the Spring Wage Negotiation, but household income and consumption are still weak and core-core CPI (excluding energy and fresh foods) eased further in April reflecting receding supply-side inflationary factors,” said Oxford Economics in a research note.

The planned reduction of bond purchase is a further step toward policy normalization. The BOJ abandoned negative interest rates and controls on bond yields in March.

“We think the BOJ should take their time progressing along that path. In our view, slow normalization of policy is best; the resulting low volatility, higher yields and steeper yield curve describe a friendly environment for bond investors,” opines Yusuke Hashimoto, Portfolio Manager—Japan Fixed Income at AllianceBernstein.

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