BoJ’s first hike in seventeen years not changing the ultra-lax nature of Japan’s monetary policy
Image from REUTERS
The Bank of Japan (BoJ) tightened for the first time in seventeen years, as widely reported by the media before its official announcement. The Bank increased its confidence to meet the 2% inflation target in the medium term, confirming the virtuous circle between wages and inflation, during the spring wage negotiation. As today’s decision was more dovish than expected, the 10-year JGB yield slightly declined while the Yen weakened (Chart 1).
On policy measures, the policy interest rate was lifted to 0.0-0.1% range from -0.1%. The yield curve control (YCC) was terminated but there was no announcement of discontinuation of purchases of Japanese Government Bonds (JGBs). Only the purchases of equity ETFs and Japanese REITs will be discontinued.
Against such backdrop, the BoJ does not seem to have any intention to start reducing its balance sheet (i.e. starting quantitative tightening). On the contrary, the purchases of JGBs by the BoJ will remain of the same size (Yen 6 trillion per month) which means that its balance sheet will continue to grow at the same pace as before (Chart 2). This is not good news from the Yen which, ironically, has further depreciated after the BoJ’s hike.
The motivation behind today’s decision with mixed messages is probably to remove the negative side effects of the YCC (especially the three-tier system for bank reserves and other distortions).
Going forward, the important question for the BoJ is whether nominal wages will continue to increase so that the 2% inflation target can be reached in a sustainable way. The ongoing wage negotiation will be crucial on this front and the data is not looking good, with weakening industrial production, consumer confidence and softening underlying inflation. Finally, in the most immediate front, the BoJ might start feeling the pressure of market participants pushing for additional rate hikes while weakening the Yen. This can only get worse if the Fed continues to delay its cuts beyond market consensus (June this year).
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