Home Finance Japan’s Monumental Rate Hike Does Not Mean the Return of Economic Normality

Japan’s Monumental Rate Hike Does Not Mean the Return of Economic Normality

by internationalbanker

By Joseph Moss, International Banker


On March 17, Japan’s central bank, the Bank of Japan (BoJ), raised its benchmark short-term interest rate for the first time in 17 years. With a rise to 0–0.1 percent from -0.1 percent, the BoJ also finally ended its eight-year negative-interest-rate policy—the last to do so among the world’s major economies—and abolished its controversial yield-curve control policy, which had capped long-term sovereign bond yields at 1 percent. The moves have raised hopes that a sense of “normalcy” may soon return to Japan’s economy after more than 30 years of economic stagnation. But with speculation growing by the day that intervention is required to prop up the yen, which currently sits at 30-year lows, and with Tokyo still facing a mountain of public debt, that normalcy may prove elusive for some time yet.

The notorious bursting of an enormous asset bubble in 1989 set the stage for Japan’s “lost decades” of economic stagnation, during which growth, inflation and wages remained almost permanently subdued. This was compounded by a declining and ageing population that has set Japan distinctly apart from other advanced economies, as well as the emergence of China as a mighty economic force that outcompeted its neighbour in cost-effective manufacturing. The rising deflationary environment eventually prompted the BoJ to adopt negative interest rates in 2016 to stimulate growth.

But that negative-rate policy ended with the BoJ’s nine board members’ 7-2 vote. The surge in global inflation and strong pent-up consumer demand following the COVID-19 pandemic led to a rise in nominal wages, with inflation returning once more to Japan. After some of Japan’s biggest companies offered major pay hikes to their workers in mid-March—which, according to one labour union confederation, saw the average base wage rate rise by 3.7 percent from 2.3 percent a year ago—the BoJ finally took action.

“The main driver of this fundamental policy change was, obviously, strong results of the annual spring-time wage negotiations, revealed just a few days before the policy meeting,” according to Seisaku Kameda, the executive economist at Japanese think tank Sompo Institute Plus, who spoke to the World Economic Forum (WEF) on March 26. “This wage growth has also exceeded current inflation rates: Japan’s CPI this February recorded an increase of 2.8 percent year-to-year. Based on these wage results and related anecdotal information obtained through the network of local branches, BOJ confirmed the virtuous cycle between wages and prices, an indispensable condition for achieving its 2 percent price stability target.”

This was confirmed by the BoJ’s governor, Kazuo Ueda, who noted after the rate hike that the likelihood of inflation stably achieving the bank’s target had “reached a certain threshold that resulted in today’s decision”. Following two years of mild inflation, “the virtuous cycle between rising wages and prices began to emerge, and the BoJ started to raise interest rates,” Tsutomu Watanabe, professor of economics at the Graduate School of Economics of the University of Tokyo and an inflation expert, recently told the Financial Times. “It’s not complete yet, but Japan is gradually heading towards a normal direction.”

But while Japan may rightfully feel that it is heading in the right direction, much of the hardest terrain to conquer before achieving that normality still lies ahead for policymakers. Indeed, given that economic growth remains fragile, Governor Ueda also cautioned against expectations of more aggressive rate hikes, adding that he “anticipates that accommodative financial conditions will be maintained for the time being”. And with annual gross domestic product (GDP) growth of just 0.4 percent in last year’s final quarter announced on March 11, having been updated from provisional figures published in mid-February of a 0.4-percent contraction, it is clear why authorities are not getting ahead of themselves.

For one, the government’s mammoth pile of public debt of almost 260 percent of GDP—easily the most among advanced economies—will surely prevent further rate hikes from transpiring any time soon. In December, the government calculated borrowing costs in its budget plan for the approaching 2024-25 fiscal year, assuming a higher interest-rate estimate of 1.9 percent instead of the initial 1.1 percent set at the time. According to these estimates, the higher assumed rates would push debt-servicing costs up by a hefty 7 percent to 27 trillion yen in fiscal year 2024-25. “When we return to life with interest rates, and if interest rates continue to rise to push up interest payments, that could affect fiscal management, squeezing policy outlay,” Minister of Finance Shunichi Suzuki said after the budget was designed.

Japan’s prime minister, Fumio Kishida, certainly believes that the Bank of Japan should continue with its expansive monetary policy and has promised that the government will coordinate closely with the BoJ to ensure wages continue to rise and the economy completely escapes its deflationary environment. “Japan is experiencing a historical chance to make a full exit from deflation. Some people may think that the government can declare that Japan is fully out of deflation. But we’re still halfway there,” Kishida told a news conference on March 28, adding that his administration’s key mandate was to bring companies and households out of a deflationary mindset. “I will promise to ensure wages increase at a pace exceeding the inflation rate next year onward,” he added.

However, the yen’s continued weakness represents the clearest argument against any return to normalcy for Japan’s economy for the time being. Having fallen to its lowest level against the US dollar of over ¥153 in mid-April, the currency’s weakness has helped Japanese exporters provide their goods and services at attractive prices to foreign buyers. In that vein, Japan’s tourist numbers have also skyrocketed recently, with monthly visitors climbing over the two-million mark.

But it has also hurt domestic consumers, who continue to suffer in the face of higher import prices, ultimately leaving them with lower disposable incomes, particularly as wages have not kept pace with the rate of currency depreciation. Indeed, the decline in spending recorded in February for Japanese households marked a staggering 12 consecutive months of annual contractions. And with reports recently surfacing that Tokyo will end its gas and power subsidies this summer, living costs are set to skyrocket in the coming months.

Much of the yen’s recent bearishness has been caused by delays in the expected rate cuts in the United States. With inflation persisting above the Federal Reserve’s (the Fed’s) target inflation level of 2 percent—March saw headline annual inflation move higher to 3.5 percent from 3.2 percent in February—doubts continue to grow over whether a rate cut will be implemented before the end of the second quarter. As such, the significant rate gap between Japan and the US, as well as Japan and many other important markets, continues to exert considerable downward pressure on its beleaguered currency to such an extent that authorities are now mulling whether to intervene. According to Suzuki, the government is “watching market moves with a high sense of urgency”, with the finance minister promising “bold measures against excessive moves without ruling out any options”.

“Whether this involves currency intervention or not, we authorities are prepared for all situations all the time,” Vice Minister of Finance for International Affairs Masato Kanda said on April 11. Meanwhile, the senior Japan economist at Oxford Economics, Norihiro Yamaguchi, stated that such an intervention is increasingly likely. The government would likely “take advantage of the opportunity to intervene after assessing how the market eventually prices in the coming rate cuts from the Fed,” Yamaguchi told The Japan Times on April 11.

Could the weak yen pressure the BoJ to lift rates further, thus potentially threatening a return to deflationary times? According to Governor Ueda, the central bank “absolutely won’t change monetary policy directly in response to exchange-rate moves”. Nonetheless, should inflation continue to creep up, Ueda suggested another rate hike could be on the table.

The central bank also confirmed that it will continue purchasing government bonds at an unchanged rate of about six trillion yen per month for the time being and execute “nimble responses” via higher government bond purchases should long-term interest rates begin to rise rapidly. However, it will scale back asset purchases by ending its acquisitions of exchange-traded funds (ETFs) and Japanese real estate investment trusts (REITs) and dial down its purchases of commercial paper and corporate bonds before completely stopping in about a year. “As for the future, we will at some point eye shrinking our balance sheet given we’ve ended our extraordinary monetary easing. But we can’t specify now when that will happen,” Ueda confirmed.


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