–Update adds comments from BOJ Governor Ueda
–BOJ Stops Targeting 10-Year JGB Yield After Capping it Around 1% But Continues Buying JGBs in 8-to-1 Vote
By Max Sato
(MaceNews) – The Bank of Japan said Tuesday its nine-member board decided in a majority vote to end its seven-year-old yield curve control framework and lift the overnight interest rate target to a range of zero to 0.1% from minus 0.1%, its first rate hike since February 2007.
Many board members believe the risk of Japan’s economy slipping back into deflation has been reduced and inflation is likely to be led by sustained wage hikes, instead of a spike in import costs, following news on Friday that wage increases for fiscal 2024 that begins next month are set to well surpass the pace of increase seen in the previous year.
But the vote on the short-term rate target was 7 to 2. Board member Toyoaki Nakamura, a former Hitachi executive, voted against the rate hike, urging the board to wait until the bank can confirm smaller firms can also raise wages. Asahi Noguchi, a former economics professor, also dissented, arguing that ending the negative rate and yield curve control at the same time could disrupt financial conditions.
“Spring wage talks became an important factor for our judgement, as we had predicted,” Governor Kazuo Ueda told a news conference Tuesday. He also said anecdotal evidence gathered through interviews with firms conducted by the bank’s Tokyo head office and regional branches showed over a half of those informally surveyed firms indicated they would raise wages.
Gradual Rate Hike Path
Asked about the pace of further rate hikes, Ueda replied, “It depends on the economic and price conditions but based on the outlook we have now, I think we can avoid a path of a drastic increase.”
The board decided to stop targeting the yield on 10-year Japanese government bonds (JGBs), which had been capped at around 0.1% under the bank’s official target of “around zero” under the yield curve control framework adopted in September 2016. It is now allowing a natural uptick in long-term interest rates that reflects economic recovery with substantial wage hikes.
The board decided in an 8 to 1 vote to continue its purchases of JGBs “with broadly the same amount as before,” which is currently about 6 trillion yen a month. In case of a rapid rise in long-term rates, the bank will “make nimble responses by, for example, increasing the amount of JGB purchases and conducting fixed-rate purchases of JGBs.” Board member Nakamura voted against the change in the way the bank targets long-term rates.
Going Back to Pre-Kuroda Easing Target
Basically, the bank revived the uncollateralized overnight interest rate “in a range of zero to 0.1%” as the main policy tool and will pay a positive 0.1% interest on excess reserves parked at the bank by financial institutions, which had been in place before it was replaced in April 2013 by quantitative and qualitative monetary easing that initially targeted the sum of cash available for economic activity.
The new guideline for market operations and the new interest rate on the current account balances will take effect on March 21.
The QQE launched by Haruhiko Kuroda, who served two five-year terms as governor until April last year, comes to an end this week but still has a legacy of leaving financial conditions accommodative, Ueda said. The accommodative environment will continue as long as the BOJ’s policy interest rate stays below the level that is considered neutral to economic activity, he said, but added that it is hard to pinpoint a neutral rate. Estimates by economists range from 0.5% to 2%.
Reducing BOJ Dominance in Stock Market
On the bank’s large-scale asset purchases that it has been using to support market and economic sentiment, the board decided unanimously to stop new purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITS), and discontinue the purchases of commercial paper and corporate bonds in about a year by reducing them gradually.
Ueda said BOJ officials are always thinking about what to do with the bank’s existing holdings of ETFs but declined comment on when and how the bank will start selling them.
The BOJ board also decided to drop its “inflation-overshooting commitment” under which it expanded the monetary base until the year-on-year rate of increase in the core CPI (excluding fresh food) would exceed 2% and stay above the target in a stable manner.
The bank downgraded its view on the current conditions, saying, “Japan’s economy has recovered moderately, although some weakness has been seen in part.” It is in line with a similar move by the government last month. The economy narrowly averted a second straight quarterly drop in October-December, and thus recession last year, but GDP for the January-March quarter is expected to contract as consumption has turned weaker amid elevated costs and production has been hit by suspended vehicle output over a safety test scandal.
Unlike other central banks, the BOJ is not raising rates to slow an overheating economy or elevated consumer inflation. It is taking the first step toward unwinding massive cash injections into the financial system after nearly 11 years of trying to reflate the economy and turn around the deflationary mindset among households and businesses. Both Governor Ueda and Deputy Governor Shinichi Uchida have said financial conditions will remain accommodative even after the bank lifts the negative short-term interest rate.
The BOJ board “assessed the virtuous cycle between wages and prices, and judged it came into sight that the price stability target of 2 percent would be achieved in a sustainable and stable manner toward the end of the projection period of January 2024 Outlook Report (throughout fiscal 2025 ending March 2026),” the bank said. “The bank considers that the policy framework of quantitative and qualitative monetary easing (QQE) and yield curve control and the negative interest rate policy to date have fulfilled their roles.”
Under the negative interest rate policy introduced in a tight 5-to-4 vote in January 2016 (effective the following month), the BOJ has charged 0.1% interest on a small portion of cash reserves parked at the bank by financial institutions, which was designed to encourage banks to lend more but was unpopular among lenders as it squeezed their profit margins.
The bank will update its economic outlook and risk analysis in the next quarterly Outlook Report due in late April. Until then, it is basically repeating its assessment used in the January report.
“Japan’s economy is likely to continue recovering moderately for the time being,supported by factors such as the materialization of pent-up demand, although it is expected to be under downward pressure stemming from a slowdown in the pace of recovery in overseas economies,” the bank said.
“Thereafter, as a virtuous cycle from income to spending gradually intensifies, Japan’s economy is projected to continue growing at a pace above its potential growth rate,” which is estimated to be zero to 0.5%, the bank said.
Looking ahead, the bank also repeated its recent assessment that “there are extremely high uncertainties” surrounding Japan’s economy including developments in overseas economic activities and prices, commodity prices as well as domestic firms’ wage- and price-setting behavior.
“Under these circumstances, it is necessary to pay due attention to developments in financial and foreign exchange markets and their impact on Japan’s economic activity and prices,” the BOJ said, also repeating its past statements.
Ueda declined comment on the yen’s lingering weakness even after the BOJ’s policy shift on Tuesday but said, “If it (the currency market) has a large impact on our economic and price outlook, we will consider monetary policy response.” Markets generally viewed the BOJ’s new policy stance as highly dovish and JGB yields declined with the yen after the policy announcement.
The BOJ maintained its latest inflation outlook that the year-on-year increase in the core CPI (excluding fresh food prices) is likely to be above 2% through fiscal 2024 ending in March 2025, due to the remaining pass-through effects of cost increases led by the past rise in import prices, but that the rate of increase will decelerate thereafter as those effects wane.
“Meanwhile, underlying CPI inflation is likely to increase gradually toward achieving the price stability target, as the output gap turns positive and as medium- to long-term inflation expectations and wage growth rise,” the bank said, repeating the January Outlook Report.