The Bank of Japan (BoJ) has been in the news lately. It lost its will for a decades-old ultra-loose monetary policy and that caused a historic tone shift that rocked the Japanese yen with damaging consequences on foreign exchange markets. Consumer inflation in Japan has finally risen above the central bank’s 2% target. Consequently, the expectation is growing for an interest rate increase in the near term as a result of this policy pivot. The BoJ’s actions and policies, particularly under the influence of Prime Minister Sanae Takaichi’s reflationary push, have positioned the yen favorably amid divergent monetary policies from other major central banks.
Bank of Japan’s Mandate and Historical Context
The Bank of Japan, as you would expect, issues banknotes. It has the duty to do monetary control in order to ensure price stability. This requires upholding an inflation target of 2% on average. In order to combat this deflation, the BoJ made a stroke of genius, or at least a daring move, in 2016. They started implementing negative interest rates and explicitly pegged the yield on their 10-year government bonds. This aggressive approach aimed to stimulate economic growth and raise inflation levels in an economy that had struggled with stagnant prices for decades.
Yet global economic circumstances shifted rapidly and drastically mainly through 2022 and into 2023. Consequently, the BoJ’s policies began to diverge in a major way from other central banks. While many were tightening their monetary policies in response to rising inflation, the BoJ continued to maintain low interest rates. This divergence became even more pronounced, creating a peculiar situation that eventually paved the way for a turnaround.
Recent Developments and Market Implications
In March 2024, the Bank of Japan lifted interest rates, marking a significant retreat from its ultra-loose policy stance that had been in place until then. This move was in response to long-run inflation that had been rising past the BoJ’s target. The upshot is that market expectations for additional rate hikes have taken root. No wonder the recent wage growth data has reinforced expectations of another hike in December.
Public outcry over the consequences of these decisions has been profound. Japan’s 10-year government bond yields rose to their highest level since 2007. At the same time, yields on the 20-year and 30-year Japanese Government Bonds exploded to their highest rates since 1999. This shift in bond yields has positively influenced the Japanese yen, as higher yields typically attract foreign investment seeking better returns.
The market was quick to respond with increased bullish sentiment surrounding the yen. Traders and investors immediately began repositioning themselves. In particular, they expected the BoJ to take additional steps to bring its policies more in line with the pickup in inflation and wage growth.
Influences Behind Policy Decisions
The recent policy changes at the Bank of Japan simultaneously reinforce and respond to all of these policies. One big reason is the continued, reflationary drive from prime minister Sanae Takaichi. The government’s massive spending plan aims to stimulate economic growth and address long-standing issues related to deflation and wage stagnation. Together, these efforts have generated a vibrant petri dish for future rate increases. The BoJ is deliberately setting its monetary policy in concert with the government’s fiscal plans.
Core inflation (excluding fresh food) was 3% in September, still above the BoJ’s target. Consequently, the central bank will continue to reinforce a hawkish tone going forward. Considering the balance between increasing wages and inflation gives us good cause to raise interest rates more. Some analysts expect that should this trend continue, the BoJ could make their first rate increase by December. They hope that this policy change might foreshadow a new approach to monetary policy in Japan.