Unwinding the unconventional: BoJ policy normalisation continues

Policy normalisation continues 

The BoJ set the stage for the start of its quantitative tightening (QT) program at its meeting in June, announcing it would consult market participants before publishing a detailed plan in July. Those consultations pre-empted the Policy Board detailing a plan to reduce JGB purchases by around JPY 400 billion (USD 2.7 billion) each calendar quarter until Q1 2026.¹ This will see BoJ JGB purchases decline from around JPY 5.7 trillion (USD 38 billion) per month in July 2024 to JPY 2.9 trillion (USD 19 billion) per month in Q1 2026 (see Chart 1). The Bank estimates its holdings of JGBs will consequently decline by around 7-8% over the next seven quarters.²

Chart 1. Planned amount of monthly BoJ JGB purchases (JPY trillion)

Source: Bank of Japan. Data as at 31 July 2024.

Additionally, the BoJ raised its policy interest rate by 15 basis points. The Bank will “encourage the uncollaterised overnight call rate to remain at around 0.25%”, having previously encouraged it to remain “around 0-0.1%”.

Gaining confidence

The continued normalisation of monetary policy in Japan reflects economic developments broadly in line with the BoJ’s outlook for activity and prices presented in April.³ Although July’s updated outlook saw the median Policy Board members’ forecast for core inflation in fiscal year 2024 fall from 2.8% to 2.5%, the forecast for fiscal year 2025 was revised up by 0.2 percentage points to 2.1%. This represents a clear signal that the Policy Board expects inflation to reach the BoJ’s 2% target sustainably (see Chart 2).⁴

Chart 2. Japan core CPI inflation and BoJ forecasts (% change, year-on-year)

Source: Bank of Japan, LSEG Data & Analytics and EFGAM calculations. Data as at 31 July 2024.

Furthermore, the Policy Board believes that the balance of risks to inflation has shifted to the upside due to import price inflation returning to positive territory, in part reflecting yen depreciation in 2024.⁵

The BoJ has been focusing on wage growth and services inflation to provide a signal that rising real incomes in Japan are supporting domestically driven inflation. As noted in a previous Macro Flash Note, the 2024 Shunto results saw the largest agreed wage increases in 33 years.⁶ July’s monetary policy decision document highlighted that wage increases have “been spreading across regions, industries, and firm sizes” and that “services prices have continued to rise moderately”.⁷ This raises the probability of further monetary policy normalisation in Japan.

Outlook

Regarding the outlook for monetary policy in Japan, it should also be noted that real interest rates remain negative, at around -2.35%.⁸ The BoJ therefore believes that monetary policy is still accommodative and will continue to support the economy. As such, if economic developments continue to unfold broadly in line with the Bank’s July forecasts, further interest rate increases should be expected.

¹ USD amount calculated using JPY USD exchange rate as at 31 July 2024.
² https://www.boj.or.jp/en/mopo/mpmdeci/mpr_2024/k240731b.pdf 
³ https://www.boj.or.jp/en/mopo/outlook/gor2404b.pdf
⁴ https://www.boj.or.jp/en/mopo/outlook/gor2407a.pdf
⁵ As of 30 July, the JPY had depreciated 8.3% against the USD in 2024.
⁶ Shunto is a Japanese term which refers to the annual Spring wage negotiations between labour unions and many large employers in Japan. See previous Macro Flash Note, “Bank of Japan exits its Negative Interest Rate policy” https://www.efginternational.com/uk/insights/2024/bank_of_japan_exits_its_negative_interest_rate_policy.html
⁷ https://www.boj.or.jp/en/mopo/mpmdeci/mpr_2024/k240731a.pdf
⁸ EFGAM estimate calculated by subtracting June’s core CPI inflation from the new policy interest rate.