By Max Sato
(MaceNews) – The Bank of Japan board appears ready to end its seven-year-old yield curve control framework and lift the negative short-term interest rate target, either this month or next, as widespread labor shortages are prompting major firms to accept higher wage hikes during their annual talks with unions, which the board hopes will bring about stable 2% inflation backed by demand, instead of higher import costs.
Although it’s not a done deal, there are heightened expectations that the bank may act at its next meeting on March 18-19, rather than at the April 25-26 meeting when it will have received more information about wages and sentiment data, to lift the negative 0.1% short-term interest rate target to around zero as part of its gradual unwinding of large-scale monetary stimulus.
It would be the bank’s first interest rate hike since 2007. The BOJ is also expected to end its policy stance to target the 10-year bond yield at a certain level, currently “around zero” with a flexible upper limit of 0.1%, as the yield curve control framework has fulfilled its role of suppressing borrowing costs and turning around the stubborn deflationary mindset. The policy tool has also been criticized for debilitating the normal pricing function of the bond market.
Public remarks by some BOJ board members point to a higher possibility of achieving the bank’s 2% inflation target after nearly 11 years of efforts to reflate the economy through massive cash injections into the financial system and keeping borrowing costs for households and businesses at low levels. They also indicate consensus among board members that the risk of the economy falling back into deflation has been reduced, although the government continues to say Japan needs economic stimulus to move completely out of deflation (it may announce that deflation is officially over in its monthly economic report later this month or next).
In a speech to business leaders last week, BOJ board member Junko Nakagawa, a former Nomura Securities executive, said that a favorable cycle between wages and prices is in sight. “There is a steady move toward achieving the 2% price stability target as seen in clear signs of change in how companies set wages,” she said.
Late last month, board member Hajime Takata, a former executive at Mizuho Securities, said in a speech that he thinks Japan’s economy “has reached the point where achievement of the price stability target has finally started to come in sight.” He called on the board to examine ways to take steps toward an exit that “involves shifting gears down from the current extremely powerful monetary easing by … terminating the yield curve control framework and the negative interest rate policy and reconsidering the treatment of the inflation-overshooting commitment.”
“I think there is a 50-50 chance (for a policy shift) between March and April,” Kazuo Momma, a former senior BOJ official and currently executive economist at Mizuho Research and Technologies, told Mace News. “It would cause no problems (to the economy) either way.”
The bank could decide to change policy after confirming what is expected to be a high pace of wage hikes in the first estimate by the Japanese Trade Union Confederation (Rengo) due on March 15, Momma said. “If the bank wants to be more cautious, it could wait until April to lift the negative rate after gathering more information from the Tankan survey (on April 1) and the branch managers’ meeting (in mid-April),” he said, referring to the key quarterly events that provide the latest business sentiment, capital investment plans, pricing behavior, labor conditions among other indicators.
Union leaders have called for wages to rise by at least 5% (3% in base wage increase) and the government plans to give a special tax deduction to firms raising wages by 7% or more. Rengo’s survey results are widely expected to show wage hikes will exceed last year’s pace (its initial estimate was 3.80%, which was later revised down to 3.58%).
Many large companies including Toyota Motor and Panasonic have accepted higher wages and bonuses demanded by unions while some firms, such as Nippon Steel, have offered to raise base wages at a higher pace than workers asked for. It is still uncertain how smaller firms, which employ about 70% of the workforce, will respond.
Momma expects the bank to end the yield curve control framework at the same time as it decides to raise the short-term interest rate target. He was assistant governor from March 2013 until May 2016, and previously, the director-general of the Monetary Affairs Department and the chief economist at the central bank.
When the BOJ ends the negative rate policy, Momma predicted, it is likely to revive the uncollateralized overnight interest rate “in a range of zero to 0.1%” as the main policy tool and apply a positive 0.1% interest on excess reserves parked at the bank by financial institutions, which had been in place before it wasreplaced in April 2013 by quantitative and qualitative monetary easing that initially targeted the sum of cash available for economic activity.
The bank’s policy shift would come at a time when Japan’s economy narrowly averted a second straight quarterly drop in October-December, and thus recession last year, but it could contract in the first quarter of 2024 as consumption remains weak and production plunged in January amid suspended vehicle output over a safety test scandal.
“The weakness of private consumption is concerning,” Momma said. “But the BOJ conducts policy in the context of its 2% inflation target. Since inflation has exceeded 2% for nearly two years, a mere shift from the negative interest rate would not hurt the economy, and given the prospect for high wage increases, private consumption can move upward.”
Looking ahead, both Governor Kazuo Ueda and Deputy Governor Shinichi Uchida have said financial conditions will remain accommodative even after the bank decides to lift the negative short-term interest rate.
“I think the bank will refrain from raising rates further for the time being as it takes time to confirm that higher wages are actually leading service prices higher,” Momma said. “They might be able to raise again in October but that would be it for this year. If service prices were to rise at a surprisingly fast pace in the spring onward, they could conduct multiple rate hikes this year and next, but I think that possibility is low.”
Nomura Research Institute Executive Economist Takahide Kiuchi, who was a BOJ board member for five years until July 2017, also expects the BOJ to be cautious about the pace of unwinding years of monetary stimulus. Kiuchi was one of the two members who voted against the yield curve control framework in September 2016, arguing that the short-term rate should be set at plus 0.1% and that the new framework would entail a risk that the BOJ might need to further increase the pace of JGB purchases.
“If the Bank of Japan were to lift the negative interest rate in March, I believe at this point that the bank would raise the policy rate (the interest rate applied to the complementary deposit facility) from the existing minus 0.1% to plus 0.1%, which would be followed, after a long interval, by another hike to 0.3% in the next spring (from March to May 2025),” Kiuchi wrote in a report published this week.
He expects the BOJ to ensure long-term interest rates remain stable before ending yield curve control, possibly in the latter half of 2024.
Under the negative interest rate policy introduced in a tight 5-to-4 vote in January 2016 (effective the following month), the BOJ charges 0.1% interest on a small portion of cash reserves parked at the bank by financial institutions, which is designed to encourage banks to lend more, but it is unpopular among lenders as it squeezes their profit margins.
Since the BOJ adopted the yield curve control framework in September 2016, it has also maintained the 10-year government bond yield, the benchmark for long-term borrowing costs, at “around zero percent” but the target has a flexible 1% upper limit after having been adjusted twice last year in the face of ripple effects of higher U.S. bond yields.
Even after the bank ends yield curve control, Kiuchi said, it is unlikely to move back to the initial stage of its quantitative and qualitative easing introduced in 2013 when it used the monetary base — the total sum of bank notes and reserves — as the main target of aggressive easing until it was replaced by the short- and long-term yield targets in 2016.
Among other topics to be discussed by the BOJ board in coming months is its asset purchase guidelines. The bank uses its dominance in domestic shareholdings to prop up equity market sentiment, which in turn should have a positive impact on economic activity, but the Tokyo stock market has hit record highs this year.
The bank currently purchases exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) “as necessary” with upper limits of about 12 trillion yen and about 180 billion yen, respectively, on annual paces of increase in their amounts outstanding. The bank has also maintained the amount outstanding of CP (commercial paper) at about 2 million yen. It purchases corporate bonds at about the same pace as prior to the pandemic, so that their amounts outstanding will gradually return to pre-pandemic levels of about 3 trillion yen.