Per other major central banks, the BoJ has an inflation target that guides policy decisions. Japanese core inflation, which excludes fresh food prices but includes energy, has been above the BoJ’s 2% target since April 2022 (see Chart 1). However, the increase in inflation in 2022 was driven by overseas influences and a weaker yen, which resulted in higher import costs and goods prices in Japan. The BoJ highlighted that for core inflation to remain at 2% in a sustainable and stable manner, underlying domestic inflationary pressures would need to be stronger. A greater contribution of services inflation to overall inflation was therefore seen as a precondition for an exit from the BoJ’s NIR policy.1 With services inflation rising above core inflation and goods inflation in January - the latest data - this condition appears to have been met.
Investment Insights • MFN
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Bank of Japan exits its Negative Interest Rate policy
At its Policy Board meeting on 19 March, the Bank of Japan (BoJ) raised interest rates for the first time since 2007, exiting its Negative Interest Rate (NIR) policy, ending the Yield Curve Control (YCC) framework and agreeing to stop purchases of other assets. In this Macro Flash Note, Economist Sam Jochim explains the changes and what can be expected from upcoming meetings.
Chart 1. Japanese consumer price index inflation (% change, year-on-year)
Source: LSEG Data & Analytics and EFGAM calculations. Data as at 19 March 2024.
The other factor the central bank has been watching closely is wage growth. Labour costs account for the majority of services costs. Hence, large wage increases are likely to lead to rising services prices. The 2024 Shunto results saw the largest agreed wage increases in 33 years.2 Thus, the BoJ believes “it is highly likely that wages will continue to increase steadily this year”.3
Chart 2. Shunto results (wage increase, %)
Source: JTUC-Rengo. Data as at 19 March 2024.
With both conditions in place - strong wage growth and strong services inflation - the BoJ’s Policy Board agreed to exit its NIR policy at its March meeting. Previously, a three-tier system was used to target policy-rate-balances of -0.1%, while allowing it to fluctuate between -0.1% to 0%.4 In the future, the BoJ will use the uncollaterized overnight call rate as its policy interest rate, encouraging it to remain at around 0 to 0.1% by applying an interest rate of 0.1% to current account balances held by financial institutions at the BoJ (see Chart 3). The BoJ described the move as an increase in its policy rate of “around 0.1%”.5
Chart 3. Short-term interest rate (uncollaterized overnight call rate)
Source: Bank of Japan. Data as at 19 March 2024.
The BoJ also exited its YCC framework, which saw it target a yield on 10-year Japanese government bonds (JGBs) of 0% with a reference upper bound of 1%. Nonetheless, the central bank will continue purchasing JPY 6 trillion (USD 40 billion) JGBs per month, which is broadly equivalent to the amount it was previously purchasing. It was also noted that this amount could be increased in case of a rapid rise in long-term interest rates. Thus, while the term YCC is no longer officially in place, the policy effectively remains available to the BoJ to use to avoid the long end of the curve rising too far and too fast.
Chart 4. YCC framework
Source: LSEG Data & Analytics and Bank of Japan. Data as at 19 March 2024.
Additionally, the BoJ announced it will discontinue purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts. Interestingly, no guidance was provided about the central bank’s current holdings and how long they would be held for. In the short-term, this implies the BoJ will maintain its portfolio holdings, but future guidance on this matter will be important for markets.6 Furthermore, the BoJ will gradually reduce its purchases of corporate bonds and will discontinue them in around one year.
The market reaction has been interesting. An increase in central bank rates is often accompanied by a stronger currency and a rise in government bond yields. However, the yen has weakened by about 1.5% since the decision and the 10-year JGB yield has declined a little. There are several explanations for this. First, there has been widespread speculation about the BoJ raising rates this year and futures were pricing the odds of a rate hike in March at around 50% - 60% in the week preceding the BoJ’s announcement. Therefore, the move was already partially priced into markets. Second, markets are sensitive to a multitude of factors, of which BoJ policy is just one – albeit significant – influence. Expectations about other central banks, international positioning and views on the state of the economic cycle, to name just a few, also play their part in driving markets. Third, while the BoJ raised rates, at the same time it delivered a dovish message about the expected future policy path.
Furthermore, despite the changes, monetary policy in Japan remains highly accommodative. A policy rate of 0.1% and core inflation rate of 2.0% equates to a real rate of -1.9%.7 Inflation is not forecast to rise significantly above the BoJ’s target in fiscal year 2024 and is expected to fall below it in fiscal year 2025.8 Thus, unless the BoJ revises its inflation forecasts upwards at its April meeting, it is reasonable to assume that further interest rate increases by the BoJ will be limited. The BoJ statement that “the Bank anticipates that accommodative financial conditions will be maintained for the time being” highlights this point.
In summary, the BoJ ended its NIR policy at its March meeting, as it believes that the conditions for inflation to reach its 2% target sustainably are in place. The central bank also exited its YCC framework, though purchases of JGBs will continue broadly at the same level as before. Nonetheless, monetary policy in Japan remains accommodative and is likely to continue to do so into next year. Unless expectations about the future policy path change, the market reaction is likely to remain muted.
1 Services inflation was highlighted by the Bank of Japan as a measure of underlying domestic inflationary pressures.
2 Shunto is a Japanese term which refers to the annual Spring wage negotiations between labour unions and many large employers in Japan: https://go.pardot.com/e/931253/-jli-documents-2021-028-03-pdf/417xq/343906710/h/Tip7rE6JgyHmAMXS2Fq3wWQb24PFbMh318-KvigeZ30
3https://go.pardot.com/e/931253/-mpmdeci-mpr-2024-k240319a-pdf/417xt/343906710/h/Tip7rE6JgyHmAMXS2Fq3wWQb24PFbMh318-KvigeZ30
4 The Bank of Japan’s three-tier system is explained in detail here: https://go.pardot.com/e/931253/mc-currency-areas-jp-htm/417xx/343906710/h/Tip7rE6JgyHmAMXS2Fq3wWQb24PFbMh318-KvigeZ30
5https://go.pardot.com/e/931253/-mpmdeci-mpr-2024-k240319b-pdf/417y1/343906710/h/Tip7rE6JgyHmAMXS2Fq3wWQb24PFbMh318-KvigeZ30
6https://go.pardot.com/e/931253/-do-with-its-475-billion-hoard/417y4/343906710/h/Tip7rE6JgyHmAMXS2Fq3wWQb24PFbMh318-KvigeZ30
7 Core inflation was 2.0% in Japan in January 2024.
8 The BoJ forecasts core inflation of 2.4% in fiscal year 2024 and 1.8% in fiscal year 2025: https://go.pardot.com/e/931253/en-mopo-outlook-gor2401b-pdf/417y7/343906710/h/Tip7rE6JgyHmAMXS2Fq3wWQb24PFbMh318-KvigeZ30