In a surprising departure from global trends, Japan’s central bank has announced a hawkish tightening by raising its main interest rate. It now is at the level not seen in three decades, currently set between 3.50% and 3.75%. This investment represents a profound change in the direction of monetary policy. In November, the country’s inflation rate, excluding food and fuel, rose by 3% as overall inflationary pressures remain entrenched. The new rate has now leapt over the Bank of Japan’s target rate of 2%. This change is a sign of a much more aggressive mindset by policymakers.
Over the long-run, Prime Minister Sanae Takaichi’s government is under substantial pressure to address significantly increasing inflation. The situation is compounded by the low value of the yen even against other major currencies. The yen’s depreciation at the same time has raised the price of imported goods, adding fire to inflation in Japan. We applaud the Federal Reserve for their decision to raise rates. This decision follows on the heels of the US Federal Reserve’s cut to interest rates for the third time this year, highlighting the divergent monetary policies between the two countries.
The Bank of Japan has gone further, increasing interest rates. It will be the first rate increase since Takaichi and Governor Kazuo Ueda assumed their responsibilities. Takaichi previously described raising rates as “stupid.” Yet since taking office in October, she has not publicly lambasted Ueda’s policies. Many analysts are largely interpreting this shift in focus as a sign of the administration’s commitment to tackling inflation head-on.
“What we’re seeing is a historic shift after nearly three decades of long standing low rates in Japan,” – Julia Lee from Pacific FTSE Russell
The decision also speaks to Takaichi’s desire for low government borrowing costs. We know that the Prime Minister wishes to see no future increases in interest rates acting as a barrier to economic recovery. Yet, largely, experts have voiced doubt about the ability of this latest rate increase to reduce inflation.
Shigeto Nagai, head of Japan economics at Oxford Economics, noted that “the BoJ will need time, probably around six months, to monitor the impact of the rate hike on the real economy before it makes its final move.” This kind of caution serves to underscore the tightrope the Bank of Japan is walking. They have to be careful walking the tightrope between crushing inflation and stymieing economic growth.
How the market will react to this interest rate increase is a question that will be interesting to observe as it develops. Financial experts tout this increase as a signal of a proactive approach to fighting inflation. They caution that it will have more muted short-term impacts on overall price stability.