Bank of Japan to keep accommodative policy after negative rate exit

What’s happened?

The monetary policy committee of the Bank of Japan (BOJ, the central bank) decided in a 7-2 vote to end its negative policy interest rate, which had been in place since 2016. The BOJ also voted to stop buying exchange-traded funds and Japan real estate investment trusts, and to gradually reduce the amount of corporate papers and corporate bonds purchased, aiming to end the purchases in one year, effectively withdrawing the quantitative easing programme. Even though the yield curve control has ended, the BOJ will continue to purchase Japanese government bonds in a flexible manner.

Why does it matter?

The catalyst for this historical move is the strong wage increase of 5.28% on average at the latest shunto annual wage negotiations between the country’s largest labour union and large companies, amid tight labour market and stronger corporate profits. The BOJ’s move signals the confidence that the rise in wages will support private consumption and prevent a return to deflation.

The BOJ has expressed concern over the strength of external demand as a key risk to the growth outlook. In our view, the risk has more to do with the strength of household consumption, which remains reliant on fiscal support. It remains uncertain if small and medium-sized enterprises (which together account for 64% of total employment) will follow suit with wage increases, which may inhibit overall household spending. Japan’s 2023 fourth-quarter GDP report lends evidence that the moderating GDP growth was largely the result of weakening private consumption (which makes up about 60% of Japan’s GDP).

However, we agree with the BOJ’s view that Japan’s economy will continue to post modest growth and that inflation will average more than 2% in 2024. The drivers of inflation will continue to be the pass-through impacts from elevated import prices and the waning effects of government subsidies for fuel and utility prices. The BOJ’s stance to keep monetary policy accommodative will be necessary to underpin modest growth and inflation throughout the year.

What next?

We expect the BOJ to assure financial markets of the continuation of its accommodative stance. The target for the policy interest rate will be maintained at 0-0.1% throughout the year. The end of negative interest rates will not lead to a dislocation in domestic financial markets or an increase in corporate bankruptcy. We do not expect a sudden big repatriation of Japanese investment to the domestic market that will lead to a major sell-off elsewhere. Although the yen weakened after the BOJ’s meeting, we believe that it will strengthen against the US dollar in the coming months, especially after the Federal Reserve (Fed, the US central bank) begins to cut interest rates later this year.

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