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BOJ is unlikely to change its policy stance


Despite growing expectations for the Bank of Japan (BOJ) to end the negative interest rates, it is unlikely for the bank to alter its policy this week. Why? One is that the bank is concerned that the move would cause a disruption in the bond markets. The second is that Japan’s wage growth is not sustainable enough to increase demand; hence, rising inflation is not backed by strong consumer spending. However, the negative interest rate has not been effective in growing its economy or inflation. That’s why the bank may have to increase its interest rate in a manner that tightens the monetary policy. Markets believe this could happen beyond April 2024.

BOJ’s concerns around economy and bond market volatility

The newly released data shows that Japan’s economy contracted the most, down 2.1% at an annualized pace in the third quarter. The national CPI rose 3.3% year on year in October, remaining above the BOJ’s target of 2%. However, the bank said that rising inflation was not supported by increasing consumer demands due to weak wage growth. Japan’s average cash earnings rose 1.5% from a year earlier in October 2023, lagging behind inflation, which led to real wages declining for the nineteenth straight month. The economic landscape certainly does not satisfy the BOJ; therefore, it is unlikely to lead to a decision to end its negative interest rate in December.

Another observation is that the Japanese 10-year bond yields have a positive correlation with the US and EU peers. The Fed’s pivot and ECB’s halt on increasing the interest rates lowered their respective Treasury yields significantly last week, which may encourage a similar movement in the Japanese counterparty. Hence, the BOJ will most likely hold its policy rate to maintain an ultra-loss monetary policy.  

Source: Bloomberg, CMC Markets as of 18 December 2023

Japan’s tightening policy is in progress

The BOJ launched a precedent negative interest rate in January 2016 after decades of deflation since a recession in the early 1990s, which was caused by housing bubbles. However, Quantitative Easing (QE) proved little effect in improving economic growth, with Japan’s GDP growth narrowing between -2% and 3% from 2016 to 2019. The pandemic was an extraordinary event for its economy, which caused a plunge in its economy, followed by a sharp rebound post-pandemic in the third quarter of 2020. At the same time, a sharp decline in the Japanese Yen and soaring energy prices have finally pushed its inflation to be above water, with an average of 3% annual increase since the third quarter of 2022.

Source: Bloomberg as of 18 December 2023


History proved that BOJ’s ultra-lose monetary policy could not support Japan’s economic growth or inflation. Instead, it may cause a long-term issue for the country’s economy. One of the significant impacts is the weakening of its currency, which, in turn, causes fund outflow and inflationary pressure. The reasons why QE couldn’t lift Japan’s economic growth include a large portion of an aging population and ineffective passage of investment funds onto households or productions. I will not go into a deep discussion of this topic here.

In conclusion, the BOJ will take a longer time before it terminates the negative interest rate. However, its tightening steps have gradually started since December 2022 when the bank increased the 10-year JGB yield cap to 0.5% from 0.25%, followed by a further expansion to 1% in July. This may bring a potential further downside pressure on USD/JPY in a long term but the pair may be expected to bounce in the near-term if the BOJ keeps its dovish tone at the upcoming meeting. 

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