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‘Blockbuster’ BOJ Decision Puts Ueda on Risky Path to More Hikes

(Bank of Japan)

(Bloomberg) -- Bank of Japan Governor Kazuo Ueda cemented his credentials as the country’s great normalizer by doubling down on efforts to drag the central bank away from the experimental fringes of global policymaking toward a more orthodox stance.

The BOJ chief and his board Wednesday raised rates for the second time this year and unveiled plans to slash in half its bond purchases after a debt-buying binge of more than a decade. 

The new interest rate of 0.25% still looks ultra-low by international standards, but it’s the highest level borrowing costs have reached in Japan since December 2008. And the central bank has already made clear that rates will only go up again if its price forecasts materialize going forward.

The double-barreled move is the latest sign that Ueda is making rapid progress in dismantling the world’s most elaborate central bank stimulus program despite the risks involved. The BOJ already ditched its control of bond yields and its negative interest rate in March. 

“Today’s BOJ meeting proved to be the blockbuster event that we have been forecasting,” said Krishna Bhimavarapu, APAC economist at State Street Global Advisors, pointing to the rate hike, bond-buying cuts and greater clarity on the policy direction. 

After initial gyrations in markets, comments by Ueda at his press briefing after the decision solidified the view that rates would continue rising. The Federal Reserve meeting later in the global day further firmed up the view that the Federal Reserve will start cutting US rates in September, helping support the yen’s momentum. 

The events kept the dollar sliding against the yen Thursday. It slipped below 149 for the first time in more than four months, while the Nikkei 225 stock index tumbled in the morning session.

Bhimavarapu expects Japan’s rates to peak at 1% next year alongside improvements in consumption and the growth prospects for the economy.

“Either way, the BOJ has taken the big bold step towards normalization,” Bhimavarapu added.

What Bloomberg Economics Says...

“Until now, we had assumed it was a relatively safe bet that the BOJ would enter an extended pause after increasing rates by 25 bps to 0.5% in October. Now we think there is a heightened risk that the BOJ forges ahead with additional rate increases in 2025.”

— Taro Kimura, economist

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Still, risks lie ahead for the central bank and the fragile transformation of Japan’s economy. After years of intensive central bank care aimed at sparking an inflation pulse, it remains to be seen if a positive cycle of rising wages, prices and growth can truly emerge. 

As monetary life support is steadily removed and rates head upward, the yen could rebound much more, hitting exporters’ earnings and a willingness to raise wages. That could reverse the nascent inflationary dynamics.

Higher yields stemming from fewer bond purchases and rising interest rates could redirect some of Japan’s portfolio investment back home, roiling overseas markets while also inflating the nation’s massive debt servicing bill. 

“Ueda has done much more to normalize policy and at a faster pace than I expected when he took the helm,” said Takeshi Minami, chief economist at Norinchukin Research Institute. He sees the next move coming as soon as October with Ueda ultimately eyeing a neutral rate of 2%.

“The question is whether the economy and inflation will really come along with what the BOJ is expecting as they become increasingly forward looking on policy. Service prices still aren’t that strong yet,” he said.

For all the talk of Japan’s resurgence in the last year or two, the economy has largely alternated between growth and contraction over that time. Consumer spending in real terms has shrunk in each of the four quarters to March as inflation eats into people’s purchasing power.

The slump in the yen to 38-year lows against the dollar in early July has meanwhile reduced per capita gross domestic product in Japan in dollars to its lowest in more than two decades.

The prospects are also looking cloudy for Prime Minister Fumio Kishida, the man who handpicked Ueda from semi-retirement in academia for one of the trickiest jobs in global central banking. 

The cost-of-living crunch generated by Japan’s inflation and its feeble yen are keeping Kishida’s approval ratings on the floor ahead of a key leadership election in September.

Two ruling party heavyweights called for rate hikes in the last couple of weeks, an indication that political patience with the BOJ may be running thin and could intensify if Kishida doesn’t survive. 

The prime minister spoke with Ueda in early May after the government had forked out more than $60 billion in total propping up the yen via intervention. The entry into the market followed the BOJ chief’s apparent lack of concern about the currency at his April briefing.

Since that conversation Japan has spent another $37 billion trying to support the yen and buy time until rising BOJ rates and falling US rates transform the direction of the currency market. Tokyo still has large reserves to take on the yen bears, but they are not limitless.

The recent strengthening in the yen ahead of Wednesday’s BOJ and Fed meetings arguably gave Ueda the cover he needed to raise rates without giving the impression there was any connection with the currency.

“The yen wasn’t necessarily the main factor behind today’s decision,” Ueda said at Wednesday’s briefing. “The main reason was that the economy and inflation have remained on track.”

Despite the doubts over the real strength of Japan’s economy, some observers see the latest moves as further evidence that the nation is on the cusp of an important change.

“Japan is stepping up the pace of monetary policy normalization,” said Jesper Koll, expert director at Monex Group Inc. and a long-running cheerleader for the nation’s equities. 

“After almost 30 years of de-facto zero interest rates and unprecedented financial socialism—the BOJ owns approximately 50% of government debt and almost 10% of the TOPIX stock market,” he said. “Capitalism is coming to Japan.”

Even if the change in Japan proves less profound than set out by Koll, it does seem that the normalization process is set to continue under the BOJ governor as he forges ahead with his mission of simplifying policy.

“Overall, I don’t see a big pitfall looming for the BOJ right away,” said Seisaku Kameda, a former BOJ chief economist now at Sompo Institute Plus. “The economy should be able to withstand one or two more rate hikes toward 1% or so. But that’s when the rate decisions will start to get tough.”

--With assistance from Isabel Reynolds, Iris Ouyang and Yoshiaki Nohara.

(Updates to reflect Fed decision and latest market moves)

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