Japan ends era of negative rates with few clues on further hikes

THE Bank of Japan (BOJ) scrapped the world’s last negative interest rate, ending the most aggressive monetary stimulus programme in modern history, while also indicating that financial conditions will stay accommodative for now.

The bank’s board voted 7-2 to set a new policy rate range of between zero and 0.1 per cent, shifting from a minus 0.1 per cent short-term interest rate, according to a statement at the conclusion of its two-day meeting on Tuesday (Mar 19).

The BOJ also scrapped its complex yield curve control programme while pledging to continue buying long-term government bonds as needed, and ended purchases of exchange-traded funds (ETFs).

The lack of signalling on any future rate hikes weighed on the yen – which slid past the closely watched 150 mark versus the US dollar – while benchmark government bond yields edged lower. The weaker currency supported Japanese equities, helping the Nikkei 225 Stock Average reclaim the key 40,000 level.

“We judged that achieving the goal of sustainable 2 per cent inflation has come within view,” governor Kazuo Ueda said at a post-decision press conference. “The large-scale monetary easing policy served its purpose.”

Ueda emphasised that even with the end of the negative rate, it is important that financial conditions remain accommodative.

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“There is still some distance to 2 per cent, if we look at it from the perspective of the expected inflation rate,” he said. “Considering the gap, I think we will conduct normal policy as I mentioned earlier, keeping the importance of maintaining an accommodative environment in mind.”

Ueda’s tone clearly showed that the BOJ’s first hike in 17 years is not the start of a pedal-to-the-metal tightening cycle of the sort seen recently in the US and Europe.

Prime Minister Fumio Kishida welcomed the hints of dovishness.

The government “believes it is appropriate that the accommodative financial environment will be maintained, from the perspective of taking a new step forward in light of the current situation and further ensuring positive economic developments”, Kishida told reporters after Ueda briefed him on the policy changes.

Still, Ueda was careful to hedge his views during the press conference. While vowing to keep policy easy until underlying price trends hit 2 per cent, he also acknowledged that if positive trends for wages and prices spur inflation expectations, risks of bigger price upswings could result in a rate hike.

“The risk of a major upward swing in this trend is not big at this point, but it is something that we need to keep in mind in the future,” he said.

The central bank’s forward guidance does not offer a clear way to figure out the pace of rate hikes, according to Masamichi Adachi, chief Japan economist at UBS Securities and a former BOJ official. Still, he said, “the BOJ is keeping the door open for another rate hike later this year”.

The movement in the yen may offer reassurance for some export company executives and equity investors that are concerned a strengthening of the currency would squeeze profits going forward. The yen extended its decline versus the US dollar to about 1 per cent at 150.68 as at 7.54 pm on Tuesday, bringing it close to the weakest level this year.

Chotaro Morita, chief strategist at All Nippon Asset Management, said that given the unprecedented degree of ultra-easing that the BOJ undertook, more tightening is inevitable.

“It’s a monumental moment, but this is just a passing point,” Morita said. “The BOJ is in the process of unwinding too much stimulus. What that means is there will be steps for tightening, which weighs on the economy in one way or the other, unlike easing.”

Turning the page

In ending the negative rate, which was imposed in 2016, Ueda turned the page on the BOJ’s experimental monetary easing programme after years in which Japan’s central bank was a global outlier. The BOJ’s move to raise borrowing costs comes just as its peers around the world are mulling cutting their rates after historically aggressive tightening campaigns.

The BOJ could not say anything about the policy path towards additional hikes because it will depend on incoming data, said economist Yuichi Kodama of the Meiji Yasuda Research Institute.

“But I think we should be ready for possibilities that the rate hike pace will happen faster than expected because wages are rising this much, which is likely to support consumer spending,” he said.

The BOJ’s move comes as other major central banks are set to hold policy rates this month. The Federal Reserve is expected to keep interest rates at a two-decade high for a fifth month as officials meet later this week.

The Bank of England is set to leave its key rate at a 16-year high of 5.25 per cent at its Mar 21 meeting, and the European Central Bank earlier this month left interest rates unchanged for a fourth meeting. The Reserve Bank of Australia announced earlier on Tuesday that its cash rate target will remain at 4.35 per cent.

High rates and a strong currency in the US have kept Japan’s 10-year yields and the yen under pressure. The yield slipped as low as 0.725 per cent after the decision, contrary to some expectations that it would rise with a rate hike and the removal of yield curve control.

The dynamic between Japanese and US rates is set to continue despite the BOJ’s hike, given ongoing strength in the US economy and resilient consumer spending there.

“This is a little bit like the party has started – but when are you coming next? Markets will push the BOJ,” said Alicia Garcia Herrero, Natixis’ chief Asia-Pacific economist.

The BOJ said a virtuous circle of wages feeding demand-led inflation is solidifying. Rengo, Japan’s biggest umbrella group for labour unions, reported on Friday that wage talks resulted in an initial deal for 5.28 per cent increases, the best outcome since 1991. That fuelled market speculation that the conditions were finally in place for a rate move, after Ueda had repeatedly emphasised the importance of wage trends.

Some 38 per cent of 50 economists surveyed by Bloomberg had expected the March rate lift-off, while another 54 per cent predicted the move would come a month later. The survey was conducted before the strong results from annual wage negotiations that fuelled widespread speculation the central bank would not wait.

As part of its policy shift, the central bank said it would ditch its buying of real estate investment trusts, too. The BOJ adopted the highly unusual measure of buying risk assets like ETFs in 2010, ultimately becoming the biggest single holder of Japanese stocks, before buying operations slowed to only three instances last year. The optics of using the measure became increasingly awkward as Japanese stocks hit a record high this month, begging the question of why the equity market needed support.

Ueda, the first former academic to take the helm at the BOJ, had previously adjusted aspects of the ultra-easy policy settings he inherited when he became governor in April, tweaking the parameters of the yield curve control in both July and October. Few analysts predicted Ueda would be able to unwind within a year so many policies that had become a headache for the central bank.

Ueda’s predecessor, Haruhiko Kuroda, launched a shock-and-awe stimulus bazooka in April 2013 with the aim of achieving 2 per cent inflation in two years. As that goal stayed out of reach, Kuroda adopted the negative rate and then the yield curve control programme in 2016. His focus thereafter increasingly fell on enhancing the sustainability of these monetary settings with policy tweaks.

The prolonged monetary easing led to an expansion of the BOJ’s balance sheet, to the point where it is now worth 127 per cent of the annual economy, four times bigger than the Federal Reserve’s assets-to-economy ratio.

Even so, inflation did not really kick in until the supply shocks triggered by Covid-19 and Russia’s war in Ukraine. Japan’s key inflation gauge has stayed at or above the 2 per cent target for 22 months, and that stretch is forecast to continue with national price data due on Friday. BLOOMBERG