Japanese core inflation, which excludes fresh food prices but includes energy prices, has fluctuated around 3% year-on-year since the beginning of fiscal year 2023-24 (FY23) (see Chart 1).1 This is above the BoJ’s 2% objective and has exceeded policy board members’ expectations, resulting in the central bank upwardly revising its forecasts for FY23 at its July meeting.
Investment Insights • MFN
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What to expect from the BoJ
The Bank of Japan (BoJ) announced it would leave policy unchanged at its meeting on 22 September. However, the recently released minutes suggest a policy shift may be on the way. In this Macro Flash Note, Economist Sam Jochim summarises.
Chart 1. Japanese core inflation and BoJ policy board members’ median forecasts (% chg. YoY)
Source: LSEG Data & Analytics, Bank of Japan and EFGAM calculations. Data as at 05 October 2023.
Despite this, the BoJ has done nothing more than tweak its Yield Curve Control (YCC) policy and has maintained a negative interest rate of -0.1% the entire year. In July, the target for the 10-year Japanese government bond (JGB) yield was left unchanged at around 0% plus-or-minus 0.5 percentage points. However, the BoJ announced that this was to be implemented with “greater flexibility”, effectively increasing the upper end of the range to 1.0% by offering to purchase 10-year JGBs at 1.0% “through fixed rate purchase operations”.2 Furthermore, the alteration to the BoJ’s YCC policy was communicated as a move to improve market functionality rather than a fundamental shift in its view on long-run inflation. The reason the BoJ opted not to alter its policy in September is that it still thinks the “sustainable and stable achievement of the price stability target, accompanied by wage increases, has not yet come in sight”.3
The BoJ views inflation in FY23 as having been driven by a pass-through of cost increases led by a rise in import prices. This has been evidenced by year-on-year goods prices increasing by more than services prices (see Chart 2). Import prices have fallen and the BoJ thinks future inflation will decline in line with this. If inflation continues to be driven by supply side factors, which monetary policy has little impact on, then the BoJ has little reason to alter its policy.
Chart 2. Goods and services inflation and import price index (% chg. YoY)
Source: LSEG Data & Analytics and EFGAM calculations. Data as at 05 October 2023.
The BoJ acknowledged in its September meeting that there is a possibility inflation will remain above its baseline scenario for some time. The important factor for policy board members is whether businesses in Japan can maintain momentum in wage rises and whether this passes through to price increases, particularly for services. Wages have increased by an average of 2.5% year-on-year in FY23 and the BoJ expects the growth rate in 2024 could exceed this (see Chart 3). Nonetheless, real wages have fallen by an average of 1.3% year-on-year in FY23 and this is not supportive of higher inflation, particularly as pent-up demand wanes. 4
Chart 3. Japanese wage index (% chg. YoY)
Source: LSEG Data & Analytics & EFGAM calculations. Data as at 05 October 2023.
While the outlook is uncertain, the BoJ expects to have a better understanding of the sustainability of inflation around January to March of next year, laying the foundations for a more meaningful alteration to its YCC policy. By highlighting in the minutes of its September meeting that the termination of its negative interest rate policy should be considered a continuation of monetary easing if real interest rates remain negative, the BoJ is also laying the groundwork for its first interest rate increase since 2007.
Much attention has been paid to the YCC policy since the surprise move in December 2022 to widen the band the 10-year JGB is allowed to fluctuate around its target from 0.25 percentage points to 0.50 percentage points. This led to a burst of volatility in the 10-year JGB market which required record amounts of purchases by the BoJ to defend its target.5 Another increase in volatility in this market is plausible following a tightening of monetary policy.
To summarise, more discussion about an exit from current policy should be expected by the BoJ at its next meeting. While inflation is currently viewed as being driven by supply side factors, it is possible that this dynamic soon changes and the BoJ expects to have more certainty early in 2024. Coincidentally, that is around the same time the BoJ’s broad review of the impact of its monetary policy over the last 25 years is expected to conclude. As such, YCC and negative interest rates may be a thing of the past in Japan by mid-2024.
1 Fiscal year 2023 began on 1 April 2023 and ends on 31 March 2024.
2 Statement on Monetary Policy July 28, 2023: https://go.pardot.com/e/931253/-mpmdeci-mpr-2023-k230728a-pdf/3mth1/274338849/h/xuR_w4hbA6IGJKZEdY5SZkRfqmibmX6RAR1oTlC_E3M
3 Summary of Opinions at the Monetary Policy Meeting on September 21 and 22, 2023: https://go.pardot.com/e/931253/inu-opinion-2023-opi230922-pdf/3mth4/274338849/h/xuR_w4hbA6IGJKZEdY5SZkRfqmibmX6RAR1oTlC_E3M
4 See also: Summary of Opinions at the Monetary Policy Meeting on September 21 and 22, 2023
5 Based on EFGAM calculations using data from LSEG Data & Analytics, as at 06 October 2023.