Neon signs in the Dotonbori district of Osaka in Japan
Alexandros Spathari | Moment | Getty Images
Japan’s central bank on Tuesday finally ended its experiment with negative interest rates and unconventional easing tools aimed at restructuring the world’s fourth-largest economy.
The Bank of Japan decision it came just days after Rengo, Japan’s largest union federation, said ongoing wage negotiations between Japan Inc and unionized workers had so far yielded a temporary weighted average increase of 3.7 percent in basic pay. That was even stronger than last year’s gains, which were the steepest in three decades.
BOJ Governor Kazuo Ueda has repeatedly said those talks would be key to sustainable price increases that would be the source of any decision to raise rates for the first time in 17 years. BOJ policymakers expect higher wages to lead to a virtuous circle with domestic demand fueling inflation.
Before Tuesday, the BOJ had just moved away from its ultra-loose monetary policy stance despite “core inflation” — which excludes food and energy prices — exceeding its 2% target for more than a year, as policy makers believed that the price increases were largely imported from abroad.
“The BOJ has taken a bit of a hit today on the expectation that very large wage increases at a large number of firms will actually lead to an increase in household spending,” Rob Carnell, head of Asia-Pacific research at ING, told CNBC on Tuesday. after the BOJ released its decision following its policy meeting in March.
“For now, they don’t know that,” he warned.
The BOJ will now look to use the short-term interest rate as its main policy tool. It will use a 0.1% rate on current account balances held by financial institutions at the central bank from March 21, while encouraging the overnight unsecured call rate (another rate used as a policy lever by the bank) to remain around 0 to 0.1% — essentially raising rates from -0.1% previously.
Shortly after the BOJ’s announcement, Japan’s largest banks, incl Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group and Mizuho Financial Groupannounced that they will raise interest rates on ordinary yen deposits.
There are a few other highlights of the policy decision:
- He said he would remove the yield curve control, which he used to cap long-term interest rates around zero. and stop the stock markets and Japanese real estate investment trusts.
- The BOJ also pledged to gradually slow purchases of commercial paper and corporate bonds, with the goal of ending the practice in about a year.
- It would resort to “agile responses” in the form of increased purchases of Japanese government bonds and purchases of fixed-rate JGBs, among others, if there is a rapid rise in long-term interest rates.
CNBC takes a look at what could happen next:
Short term impact
The decision on Tuesday sparked a sharp sell-off in the Japanese yen extended until Wednesday.
The yen fell to its weakest against the euro since 2008 on Wednesday. The Japanese currency also fell against the dollartrading at a four-month low of around ¥151 — weaker than the ¥150 level that previously prompted some form of intervention by Japanese authorities.
At the news conference after the decision, Ueda said a “rapid” rate of increase was unlikely given the fragile economic outlook for the economy — a prospect that likely dismayed some Japanese yen bulls, according to Michael Brown, senior research strategist at Pepperstone forex broker. .
In fact, the BOJ warned in its initial announcement that it would not pursue aggressive rate hikes, saying it “expects accommodative economic conditions to remain for now.”
At Tuesday’s press conference, Ueda did not commit to a timetable for shrinking the BOJ’s balance sheet, nor did he give clear indications of further rate hikes or a terminal rate level.
The global rates team from Bank of America – among those in the market predicting the BOJ’s move after a litany of local Japanese news last week – said they expected a “limited” immediate impact globally as action is already well priced .
The BofA team also noted that just because the BOJ dropped the yield curve control framework, that doesn’t mean it will lead to a sharp rise in government bond yields (JGBs). That’s likely because the BOJ says it will continue to buy “broadly the same amount” of government bonds as before — currently about 6 trillion yen a month.
Barclays economists said that a reduction at the upper limit of bid sizes for JGBs suggests that the BOJ is looking to gradually reduce its purchases.
Long-term concerns
One of the biggest fears is the extent of any repatriation to Japan.
Decades of accommodative monetary policy in Japan — even as other global central banks tightened over the past 12 months — have also concentrated carry trades in the Japanese yen, given the huge interest rate differential between Japan and the US and other parts of the world. keeping the Japanese yen weak. Carry transactions involve borrowing in a low-yielding currency to finance investment in higher-yielding assets elsewhere.
The weakening of the traditional yen along with the return of Japanese capital to the domestic bond market could cause broader volatility. Japanese investors have looked elsewhere for better returns given the chronic artificially low interest rates in their home market.
But with the BOJ unlikely to raise interest rates aggressively, there appears to be little chance of a sharp fall in the spread between US Treasuries and JGBs that currently exceeds 300 basis points, said Vishnu Varathan, chief Asia economist at Mizuho , formerly Japanese.
“While [an] unexpected dove turn from the [U.S. Federal Reserve] it’s a completely different proposition.”
The Fed is due to announce its own rate decision on Wednesday.
In the longer term, Hayden Briscoe, head of APAC multi-asset portfolio management at UBS Asset Management, said there will be a gradual rise in bond yields, say blocks of 25, 50 points, [to] make sure the markets work.”
Briscoe believes it will take some time for the BOJ to make more changes to the key rate, noting that they “don’t want to scare people with short-term rates going up aggressively while the year [yields are] under pressure.”
So what he thinks the central bank will do is allow the longer end of the yield curve to start “spinning” higher slowly, then if the BOJ sees demand and prices rising due to higher wages, then the bank will “start pushing cash prices back up”.
However, Briscoe says that move won’t happen anytime soon.
“Whether the Bank of Japan decides to raise interest rates is not what matters at the March or April meetings. We will focus on the entirety of the announced policy change, along with what it does to expectations for more of the same,” Steven Major, global head of fixed income research at HSBC, said in a note ahead of the BOJ’s historic move.
“Something big in Japan is about to happen,” he added.
— CNBC’s Shreyashi Sanyal contributed to this story.
Correction: This story has been updated with the correct name for inflation when the measure excludes food and energy prices.