The Inevitability Of Japan To Adjust Its Monetary Policy – Analysis

By Wei Hongxu*

The Japanese government officially nominated academic economist Kazuo Ueda as the next central bank governor on February 14. This unexpected decision also makes the direction of the Bank of Japan’s (BOJ) monetary policy, which has been under market scrutiny, to be even more difficult to grasp. On the same day, the yen edged higher against the dollar. Most Japanese stock indexes maintained their gains, with the Nikkei 225 climbing 0.6%. This reaction shows that the market still has a more cautious optimism about the BOJ’s policy changes.

However, researchers at ANBOUND had p previously pointed out that the BOJ still faces a huge dilemma in the case of inflation exceeding the target, as well as international capital betting on a change in the country’s monetary policy. This also led to its monetary policy facing uncertainty. In addition, according to previous reports in the Japanese media, three potentially popular candidates for governor, whether they adhere to the super-easy policy, including Masayoshi Amamiya, or quantitative easing policy critic former BOJ deputy governor Yukio Yamaguchi, as well as another former deputy governor Hiro Nakasone are unwilling to assume this position. This not only reflects the quandary facing BOJ but also the fact that Kazuo Ueda becomes the new governor indicates the very few alternatives left for the Japanese government.

There is not much information about Ueda’s thoughts on Japan’s monetary policy and the Japanese economy, and very little is known about his views and position on the direction. Considering his experiences, Ueda is arguably one of those most familiar with the BOJ’s quantitative easing policy. However, he has been more pragmatic in expressing his views on inflation in several articles published last year. As the current changes in the market remain unclear, this reflects there is continued unpredictability about Japan’s policy orientation. ANBOUND’s researchers have noted that this great uncertainty of the BOJ’s policy trend is the main “black swan” affecting international capital markets this year.

It is worth noting that the trend of Japanese funds retreating from overseas has already begun. Whether or not the BOJ adjusts its policy, uncertainty continues to remain, which is one of the reasons why funds began to retreat to avoid risk. JP Morgan’s report foresees that Japanese portfolios will continue to shift from overseas debt to the country’s domestic debt this year. By the end of 2022, Japanese investors have turned into net sellers in 14 of the 20 major global fixed-income markets. Among them, the markets with the largest outflows were Europe and Australia. It was also in 2022 that Japanese investors sold a record USD 181 billion in foreign debt and injected JPY 30.3 trillion (USD 231 billion) into the Japanese local government bond market, according to the latest data from Japan’s Ministry of Finance and the Japan Securities Dealers Association. Due to the long-standing negative interest rate policy, Japanese investors both inside and outside of the country have used the yen as a safe-haven currency and a zero-cost currency, and the current uncertainty of the BOJ’s policy has led investors to take the initiative to reduce their yen liabilities and to minimize the risk. If there is a scenario where Japanese investors sell the foreign debt on a large scale and funds flow back to their home country, the global bond market and even all financial markets will perhaps see another round of turmoil.

However, Japan’s economic growth in 2022 was only 1.1%, and the performance remains sluggish while inflation continues to be high. This has caused the continuity of Abenomics which advocates quantitative easing policy to be constantly questioned. As the Federal Reserve continues to tighten its policy and the interest rate differential between Japan and the U.S. continues to widen, Japan’s ability to withstand the negative economic impact of the trade deficit, as well as inflation brought about by the continued depreciation of the yen has been doubtful. In the opinion of researchers at ANBOUND, the space for the BOJ to continue its easing policy is now rather narrow, where it has become the largest buyer of Japanese government bonds and ETF funds. The strong dollar brought about by the Fed’s interest rate hike too has made the yen under great pressure. Because of this, certain speculative capital is now constantly betting that the BOJ will adjust its policy of yield curve control (YCC) to allow interest rates to rise, causing the Japanese central bank to be in an awkward, dangerous situation.

Because of this, many market participants are aware that the change of the BOJ governor in April will be an opportunity for a policy shift. That being said, neither pragmatic policy tightening adjustment nor continued easing will be an easy task for Ueda. Continued easing will lead to a narrower path and generate more risks in the long run; while tightening policy or even raising interest rates will inevitably lead to market turmoil. In the end, whether a soft landing can be achieved will be a test for the new governor.

Final analysis conclusion:

Kazuo Ueda has been unexpectedly nominated by the Japanese government as the new Governor of the Bank of Japan, a surprise in terms of policy changes for the central bank. This also makes the future orientation of the BOJ’s monetary policy remain uncertain. Yet, from the point of view of the changing situation, such policy adjustment has been the general trend. The challenge for the new governor, as things stand, is to avoid bringing turmoil to the market.

Wei Hongxu is a researcher at ANBOUND