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Emboldened BOJ takes hawkish tilt
08 Aug 2024
By Peiqian Liu, Asia Economist
The Bank of Japan has set itself firmly on the path of further policy normalisation with a rate hike. But how far and fast the central bank will go from here remains an open question.
What happened
The Bank of Japan (BOJ) brought the benchmark interest rate to around a quarter of a per cent, up from the tight range of zero to 0.1 per cent on 31 July. In a step change, the bank appears to be more guarded against prices racing higher, than against the risk of growth losing momentum. It sees the consumer price index (CPI) rising at 2.1 per cent next year, 0.2 percentage point higher than in previous projections and above its two per cent target.
The bank also announced further steps to reduce Japanese government bond (JGB) purchases - a hallmark of its ultraloose policy of the past decade. It will cut these purchases gradually - by JPY 400 billion each quarter - to around JPY 3 trillion (USD $19 billion) in March 2026, which will reduce the central bank’s JGB holdings by between seven and eight per cent. However, the bank has reserved the option to slow this down if yields spike, and will conduct an assessment next June for plans beyond the first quarter of 2026.
Hanging over the big announcement was the yen’s recent weakness. A softer yen means more expensive imports for Japan. While exchange rate stability is not part of the BOJ’s mandate, Governor Kazuo Ueda admitted that the yen is having more influence over domestic inflation than before, which helped build the case for a rate hike in July.
Our interpretation
With import prices rising, and wages and prices tracking each other more consistently, the timing of the BOJ’s decision shouldn’t come as a surprise.
But the bank’s forward guidance was more hawkish than markets expected, signalling further hikes down the road if prices prove to be sticky. Speaking after the policy meeting, the governor refused to put a ceiling on the policy rate at 0.5 per cent.
One explanation for the BOJ’s stance is that real rates are still very low, even after July’s hike. Financial conditions also continue to be accommodative, which is probably why the governor sounded relaxed about the potential economic side-effects of his decision. Only two of the BOJ’s board members dissented to the rate hike.
The only dovish outcome was the unwinding of JGB purchases. The timeline is long, and the BOJ retains some flexibility over its implementation.
Outlook
The door is now open for further hikes. But just how fast and steep the BOJ will hike depends on inflation’s trajectory (Ueda has been assiduously data-dependent). That in turn hinges on yen weakness and imported inflation - don’t underestimate the possibility of the BOJ speeding up interest rate increases if the spread between Japanese and US yields widens significantly again.
We are more optimistic on the virtuous cycle between wage growth and higher prices in Japan. That will likely be sustained, and therefore imply a higher neutral rate for the country. Should the wage-price cycle gain momentum, the BOJ may need to hike more - just to keep inflation in check at that two per cent target.
Asset allocation views
Fidelity Solutions & Multi Asset currently has an overweight view of Japanese equities as Japan’s structural story remains intact. It has turned a corner from disinflation and corporate governance is improving. The BOJ may continue to hike gradually to tame inflation. However, we remain neutral on USDJPY because the BOJ’s policy normalisation alone won’t be enough for a yen rally. That would require more aggressive easing by the US Federal Reserve.
