Unlock Editor’s Digest for free
FT editor Roula Khalaf has chosen her favorite stories in this weekly newsletter.
Bank of Japan policymakers are grappling with a series of difficult policy discussions as they face the reality of raising interest rates for the first time since the summer of 2006.
Japan’s central bank has signaled it is almost ready to end the era of unprecedented cheap money, with the first interest rate hike expected as early as March or April, but negative interest rates. We still face a number of difficult decisions about how to leave interest rates negative without triggering a crisis. There will be turmoil in the world market and Japanese financial institutions.
Among those issues is whether to first raise interest rates to zero or directly into positive territory. What to do with the central bank’s huge bond portfolio? And most importantly, what does this tell us about the path of interest rates since the initial rise?
Takafumi Yamawaki, head of Japanese interest rate research at JPMorgan, said, “The Bank of Japan really doesn’t get into the details.” He said: “The government has said it wants continuity, but it’s difficult to say whether that applies just to the policy rate or elsewhere.”
On the first issue, Bank of Japan officials are close to making a decision and are likely to raise the policy rate by 20 basis points to 0.1%.in recent speechesBank of Japan Deputy Governor Shinichi Uchida suggested this could push money market interest rates from just below zero to a range of zero to 0.1%.
The difficult question of whether the Bank of Japan will abandon the complex three-tier interest rate system for central bank deposits it introduced eight years ago to facilitate trading in the interbank market and limit the hit to bank profits remains. negative interest rate policy.
“The most obvious path would be to abolish tiering,” said Stefan Anrik, senior economist at Moody’s Analytics. “The Bank of Japan had a zero interest rate policy and didn’t have a tiered system in place at the time, so it’s completely logical.”
But Izuru Kato, a longtime BOJ watcher and chief economist at Totan Research, says it won’t be easy to return to the pre-2016 situation. Once the tier system is abolished, there will be little incentive for banks to trade in money markets unless the BOJ starts shrinking its balance sheet to reduce excess reserves.
Kato pointed out that even after the Swiss central bank returned to positive policy rates in 2022, it maintained graded levels of reserve requirements for the same reason, and the Bank of Japan introduced a two-tier system to prevent a decline in interbank transactions. He said that there is a possibility that it will be maintained.
The Bank of Japan is unlikely to make any drastic move toward quantitative tightening in its bond portfolio, such as suspending asset purchases or selling assets. Instead, officials believe they can use the uneven maturity schedule to gradually shrink their portfolios while continuing to buy new bonds.
The annual maturity of the portfolio is expected to be approximately 70 trillion yen ($470 billion) over the next few years. With the Bank of Japan’s bond purchases remaining at that pace, even a slight adjustment to the purchasing schedule could send the portfolio into decline.
Technical decisions aside, what is clear is that the BOJ’s path to policy normalization will only begin once the US Federal Reserve and European Central Bank implement a series of interest rate hikes in 2022 to curb inflation. This means that it is different from the other way.
Japan’s economy grew by just 0.1% on a quarterly basis in the last three months of 2023 due to sluggish consumption, but the recent sharp rise in prices that policymakers had welcomed after years of deflation has already begun. It looks like it’s coming to an end. Core inflation slowed for the third straight month in January, stabilizing at the Bank of Japan’s 2% target.
This means interest rates are likely to remain very low for some time to come, and BOJ officials are not viewing the first rate hike as a sign that further hikes will soon follow.
In his speech, Uchida emphasized that Japan’s situation cannot be compared with that of the United States or Europe because inflation expectations have not yet settled at 2% after a long period of deflation and economic stagnation.
“Even if the negative interest rate policy is lifted, it is difficult to imagine a path to rapidly raising interest rates thereafter,” he said.
Market participants remain divided on how slow the pace of rise will be. Yamawaki and UBS expect the policy rate to remain at zero or 0.1% until 2025, while Morgan Stanley expects the policy rate to rise to 0.25% by July.
The IMF has recommended that the Bank of Japan lift policy interest rates over the next few years after ending its policy of capping 10-year government bond yields and ending quantitative and qualitative easing. But he added that the process should be done in stages.
“We agree with the Bank of Japan that there remains considerable uncertainty about the path of inflation,” IMF First Deputy Managing Director Gita Gopinath said at a recent press conference in Tokyo. “Given the history of deflationary pressures, I think it’s right to be cautious.”
One of the biggest uncertainties is upward pressure on wages. Japan’s largest companies have indicated they intend to raise wages in this year’s spring negotiations, which are scheduled to end later this month.
However, Kazuo Monma, a former head of monetary policy at the Bank of Japan and now an executive economist at Mizuho Research Institute, said stronger wage increases for small and medium-sized enterprises are needed to justify a second hike in policy rates. .
Household consumption could start to pick up in the second half of this year if inflation eases and real wages rise, Monma said. “If that happens, there could be another rate hike before the end of the year.”
