- The BoJ’s latest move heralds a return to more normal economic conditions
- But what does it mean for investors?
On 19 March, the Bank of Japan (BoJ) made some relatively minor-sounding tweaks to monetary policy. The cap on 10-year government bond yields was removed, the BoJ said it would stop buying exchange traded funds and real estate investment trusts, and rate-setters nudged the policy rate up from -0.1 to a 0-0.1 per cent range.
The changes might look subtle, but the consequences feel far more profound. The Japanese economy had long battled low growth and periods of deflation, leading to an extremely loose monetary policy stance. The latest move represented the BoJ’s first interest rate hike in 17 years (see chart), and scrapped the world’s last remaining negative interest rate. Chris Scicluna, head of research at Daiwa Capital Markets Europe, called the move a “turning point”, adding that “the crisis-era monetary policy in Japan is finally coming to an end”.
Although Japan has not been entirely immune to the forces that pushed up global inflation over the past two years, the economy has seen a far more muted acceleration. The annual inflation rate rose from -1.2 per cent at the end of 2020 to a peak of around 4.5 per cent in the middle of last year. Unlike policymakers elsewhere, Japanese central bankers are keen for higher inflation to take hold and feed into higher wage demands.
A look at the recent past helps us understand why. Since 2009, Japanese inflation has averaged just 0.6 per cent (or 0.25 per cent if we exclude the recent surge); the corresponding figure for the UK is far closer to the inflation target at 3 per cent, or 2 per cent if recent events are excluded.
Howe Chung Wan, head of Asian fixed income at Principal Asset Management, points out that “a large portion of the working population has never experienced a high-growth Japan, so confidence will take time to build.” Workers have far lower inflation expectations, and set their wage demands accordingly.
Why further hikes are unlikely
The BoJ now judges it “highly likely” that wages will continue to increase steadily this year, and were heartened by the results of this year’s union wage negotiations. Yet further ahead, they expect the rate of price growth to slow again – and are treading cautiously as a result. Policymakers stressed that “accommodative financial conditions will be maintained for the time being”, and the BoJ plans to maintain its policy of buying Y6tn-worth of government bonds a month.
With rates still on hold at the other major central banks, the BoJ has managed to squeeze in a hike at the very end of the global tightening cycle. Yet Japan's interest rates will not catch up with its peers. Many economists see no scope for further increases over the next few months, while analysts at Societe Generale think that rates will edge up to just 0.25 per cent in October.
This means that movements in the yen this year will probably be driven by action elsewhere. The yen weakened 0.8 per cent against the dollar following the announcement, as markets responded to the absence of a steer from the BoJ on further rate hikes. Analysts at Dutch Bank ING expect the USD/JPY exchange rate to hover around 150, only moving to 140 later in the year as the Fed’s easing cycle hits full swing.
What this means for investors
The good news is that Japan’s transition to more ‘normal’ monetary policy has so far been remarkably smooth. ING economists said that governor Kazuo Ueda deserves “kudos” for managing the changes without dislocating financial markets. This month's policy changes were met with a calm reception, with the yield on a 10-year Japanese government bond dipping to 0.725 per cent and the Nikkei 225 closing 0.7 per cent higher on the day. In February, the index finally surpassed the bubble era high it reached over 30 years ago.
A stable backdrop is not the only thing supporting Japanese markets. Ben Powell, chief Asia-Pacific (Apac) investment strategist at the BlackRock Investment Institute, thinks that the outlook for Japanese stocks could be buoyed further thanks to healthy earnings momentum, shareholder-friendly reforms and valuation support from (still) a favourable interest rate backdrop. According to Powell, “the sun is not setting on Japanese equities, in our view; it is merely rising on a new horizon”.
