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November 9, 2023

The Bank of Japan’s "tweak and hold" as inflation ratchets higher

The BoJ sought flexibility before any “lift-off” from negative rates
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In-house blogger
Guest blogger
Tetsuo Harry Ishihara
Strategist, Macrobond consultant, and former adviser to Japanese regulators
All opinions expressed in this content are those of the contributor(s) and do not reflect the views of Macrobond Financial AB.
All written and electronic communication from Macrobond Financial AB is for information or marketing purposes and does not qualify as substantive research.

Kazuo Ueda didn’t think markets would test his relatively new 1 percent cap on the 10-year Japanese government bond yield so soon.

The Bank of Japan had only just adjusted the yield curve control (YCC) policy in July, widening the acceptable range from 0.5 percent. But US yields kept rising, and domestic inflation in Japan proved to be stickier than expected.

So in an Oct. 31 Halloween surprise, the BOJ made 1 percent a “reference point” instead – shown as a dotted line on the next chart. The central bank ceased its powerful unlimited daily bond buying operation, which had enforced the former cap. 

This move 1) will prevent the BOJ from overloading its balance sheet with JGBs, 2) makes its accommodative stance more sustainable, and 3) should slightly improve market functioning. 

But why is that 1 percent level still the reference point?

As we have previously written, a BOJ official has explained its theory as follows: the 1 percent level is the sum of an estimated neutral rate of 0, plus their 2 percent inflation target, minus 1 percent from YCC. The hope is that yields above 1 percent should be short-lived. (However, the new dotted line is already being tested, as the chart shows.)

That was the “tweak.” But now, on to the “hold.”

Negative rates – and inflation critics – persist

Meanwhile, the world’s last negative interest rate policy (or NIRP) was kept on hold at minus 0.10 percent. The BOJ also retained its long-term YCC “target” of 0 percent (the “cap” and “reference point” levels give them flexibility to achieve this target.) 

These policy stances were maintained because the central bank said its 2 percent target of stable and sustained inflation - supported by wages – “now feels closer” but is “not yet attained.” Reflecting this outlook, the BOJ changed its FY2024 inflation forecast from 1.9 percent to 2.8 percent.

As the following charts show, the BOJ’s critics have ammunition when they say that even the central bank’s three measures of underlying inflation - the trimmed mean, the mode, and the weighted median - have all passed their targets. 

The weighted median’s rise is especially surprising. It had been stuck at zero for years - earning it the nickname “the invariable inflation index”.

As well, almost 90 percent of the items in the CPI are now experiencing price increases. Food inflation is 9 percent, which appears to be a 47-year high. 

(Food accounts for 2.4 percentage points of the 3.1 percent growth in headline CPI – by far the biggest driver.)

An apologetic Governor and an important inflation forecast

Flashing a sheepish grin at the BOJ’s press conference, Ueda said he was sorry that “our forecasts have underestimated inflation for so long.”

“Although import costs have slowed, the pass-through of those costs has continued for longer than expected,” he added. “That effect should abate soon.”

Back to that inflation forecast, which was extremely important. 

Changing the FY2024 median inflation forecast from 1.9 percent in July to 2.8 percent in October implies that the BOJ expects inflation to be well above target for three years in a row.

(FY2022 was 3 percent, FY2023’s forecast is 2.8 percent, and FY2024’s forecast is also 2.8 percent).

In light of this, the now-positive yield curve, as seen in the next chart, reflects a consensus that NIRP will finally end soon. 

"A Japan with positive rates" next year?

The BOJ followed Europe1 into the world of NIRP in early 2016. This had a psychological impact on the nation. Major hardware stores warned consumers “are you prepared for negative rates?” and offered up fireproof home safes. (Sales surged.)

Ultimately, NIRP was only applied to bank reserves at the BOJ; today, it is mostly symbolic, only applying to a tiny portion of such reserves.

Nevertheless, lift-off from NIRP could have wide-ranging effects. And again, the prospect is having an impact on consumers and the media. One magazine recently published a series of articles titled “A Japan With Positive Rates2.” A headline from a newspaper trumpeted “Ten-year time deposit rates increase 100 times!” (… 0.2 percent.)

In this context, the upcoming wage survey from Rengo (the labour organisation representing 5000 unions) in late March “remains key,” the BOJ said, adding that it now has “some confidence” in wage growth.

This past February, Rengo called for wage hikes of about 5 percent; next February, that demand will probably change to “at least” 5 percent.

Meanwhile, Prime Minister Kishida continues to stress that “wage growth is key” for the virtuous economic cycle he is seeking.

A tightening labour market is a tailwind for inflation, but its effects are getting extreme. Corporates are announcing forward wage guidance to nab recruits. Bus routes are being cancelled due to a lack of drivers. The Ministry of Health is testing shuttle services to serve senior citizens who want to work.3

With BOJ staff conducting their own wage surveys, a go/no-go decision on lift-off could possibly be made before the Rengo survey. However, the consensus view is that the end of NIRP won’t come before April.

"Extremely high uncertainties" and the weak yen

What could change that consensus view? Ueda warned of “extremely high uncertainties,” without going into detail. Here are some scenarios that come to mind:

  • Wage growth could underwhelm. Corporates and unions have historically made reference to inflation when negotiating wages. When this year’s negotiations began in February, January’s core CPI was 4.2 percent; that has slowed to 2.8 percent. 
  • Developments overseas and in the markets. For instance: a) US long-term rates often move the yen, which is a major driver of inflation – both upwards and downwards. b) Japan is reliant on oil from the Middle East, where conflict has erupted and could disrupt supply. c) China’s economy could slow more than expected.
  • Uncertainty to the upside from Japan’s inflation revolution. The highest inflation in 40 years has been a net positive for Japan, and the BOJ had a lot of nice things to say. Corporate profits. Corporate sentiment. Capex. Consumer spending. Consumer sentiment. Employment. Wage growth. Inbound tourism. Improving output gap. Improving potential GDP. The weaker yen has been welcomed by major corporates; for some automakers, every 1 yen of weakening improves annual profits by an estimated 300 to 400 million dollars. 

Finally, it’s worth discussing the yen’s inflationary weakness. The BOJ cited recent exchange-rate volatility as a factor for the latest tweak. 

The government has disclosed that contrary to speculation, the Ministry of Finance did not intervene in early October, when the yen strengthened by nearly 3 yen in one minute after hitting 150 versus the dollar. That disclosure, combined with BOJ’s “tweak and hold,” caused the yen to plunge through the 151.70 level on Oct. 31 - approaching its weakest level in 33 years.

To summarise all this news – the BOJ may want to execute lift-off soon.

During a parliamentary hearing on Nov. 8, Governor Ueda hinted that real wage growth – which has been shrinking for 18 consecutive months, angering voters - does NOT need to turn positive for lift-off. 

That contradicts a statement he reportedly made to former students earlier this year. This could be a smart response designed to keep the governor’s options open, a move he tends to prefer – or it might be a hint of changes coming soon.

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