By Wei Hongxu
With the market continuing to increase expectations for Japan’s monetary policy shift, on January 18, the Bank of Japan (BOJ) decided to maintain its loose monetary policy, keeping the benchmark interest rate at a historical low of -0.1%, and the 10-year government bond yield target to be close to 0%. On the other hand, the yield curve control (YCC) was kept unchanged, and the floating range of Japanese bonds was not raised again as previously speculated. This decision also caused the reaction of the international capital market. After the announcement of the resolution, as of noon, the Nikkei 225 index rose by 2% within a day; the USD rose rapidly against the JPY in the short term, breaking through the 130 mark, and the 10-year Japanese government bond yield fell to 0.497%.
The reason why the international capital market pays attention to the monetary policy of the BOJ is that in December last year, the central bank unexpectedly expanded the upper limit of the regional control rate of yield from -0.25% to 0.25% to -0.5% to 0.5%. This change is understood by the market as a precursor to changes in Japan’s loose policy. This also caused the JPY to appreciate and the Japanese stock market to fall sharply. Previously, the long-term quantitative easing policy of the country made the JPY an international safe-haven currency, which also resulted in international capital borrowing heavily from Japan as the main provider of long-term funds. If Japan’s monetary policy changes, it will naturally cause turmoil in the international capital market. Therefore, many investors are currently paying special attention to whether Japan will promote a shift in monetary policy.
In recent years, with the outbreak of the COVID-19 pandemic and the intensification of geopolitical, Japan is also threatened by global inflation, hence it has a theoretical basis to adjust its monetary policy. This is particularly true after the Federal Reserve and the European Central Bank withdrew their quantitative easing policies one after another and began to raise interest rates, the policy gap between the BOJ with Europe and the United States has gradually widened. This, in turn, drove the depreciation of the JPY in 2022. Yet, the depreciation of the JPY has not stimulated the growth of Japan’s foreign exports as before. On the contrary, the high energy prices have caused Japan to experience a trade deficit that has not been seen in many years, further stimulating the rise of the country’s domestic price level. According to data published by the Japanese Ministry of Internal Affairs and Communications, in November 2022, Japan’s overall CPI rose by 3.8%, and the core CPI excluding fresh food prices rose by 3.7% from the same period last year, setting a 40-year high. This also exceeded the BOJ’s core inflation target of 2% for several months. It is the long-term high inflation level in Japan that makes the outside world believe that Japan could follow in the footsteps of Europe and the U.S. to change the quantitative easing policy that has lasted for many years. Because of this, when Japan insisted that its loose policy would be unchanged, Japanese government bonds suffered a large sell-off, making the BOJ almost the only buyer of Japanese government bonds, putting its YCC policy under unprecedented pressure.
Japan’s tightening monetary policy has not eased concerns about the country’s economic outlook. On January 18, the BOJ lowered its economic growth forecast and raised its CPI forecast. It expected GDP growth of 1.9% in the fiscal year 2022, compared with the previous expectation of 2.0%; 1.7% in 2023, compared with the previous expectation of 1.9%; and 1.1% in 2024, compared with the previous expectation of 1.5%. The Japanese central bank also raised its median core CPI forecast for FY2022 and FY2024 while lowering its GDP growth forecast for FY2022, FY2023, and FY2024. The persistence of inflation and the sluggish economy put the BOJ in a dilemma where it has lost its reason to continue easing and is unwilling to raise interest rates to damage the economy that is recovering now. With the term of BOJ Governor Haruhiko Kuroda approaching, there is speculation that the change of the central bank governor may be an opportunity for it to change the policy.
That being said, such policy change is more likely to shock the market. The game between the capital market and the BOJ is still going on because the market generally expects the central bank to exit quantitative easing. In order to defend the promise of “unlimited bond purchases”, the BOJ continued to sweep the bond market in October last year, and 70% of the 10-year government bonds were held by it. After the YCC floating range was suddenly adjusted to 0.5% on December 20 last year, the operation of the Japanese government bond market became more and more distorted. Investors accelerated their selling of Japanese bonds under the expectation that the central bank would withdraw from quantitative easing, and the BOJ had to continue to buy large amounts of bonds to defend YCC policy. As a result, the BOJ bought about JPY 12 trillion in just four trading days earlier in January. According to industry estimates, just halfway through January, the bank’s share in the Japanese government bond market has jumped to 53%. Bloomberg estimates that at this rate, the BOJ will buy all the Japanese debt within a year. From this point of view, Japan’s relaxation of the upper limit of YCC control in December last year not only failed to relieve the pressure but has actually further increased market speculation.
For international capital markets, especially emerging markets, uncertainty about the policy will also continue to have an impact. Now, Japan’s delay in changing its policy does not ease concerns, the continuation of uncertainty is more disturbing. Some analysts believe that, in a sense, if the BOJ continues to defend its easing policy, the market reaction may even be greater, as a large number of investors who bet in advance before the resolution, may be eager to change their positions based on expectations of a policy shift. On January 18, after the BOJ kept interest rates unchanged at ultra-low levels, the USD surged 2.5% against the JPY, putting further pressure on emerging Asian currencies. The fall was led by the Thai baht, which fell by up to 0.6% during the day.
If the BOJ changes its monetary policy, the consequences will be challenging. On the one hand, the Japanese stock market is under pressure again due to rising interest rates; on the other hand, its policy shift does not prevent the short-term selling of Japanese government bonds. Some analysts believe that any change in the policy may trigger a sharp rise in the JPY and long-term Japanese bond yields because it will fuel the market’s expectations for the end of ultra-loose monetary policy in the short term. JPMorgan expects that a shift in Japanese policy could bring about a 4% to 5% appreciation of the JPY, which would attract international capital back to Japan and exacerbate the global liquidity deficit. For China, South Korea, and Southeast Asian countries with close economic and trade ties to Japan, it will also bring about exchange rate volatility, affecting the stability of local financial markets.
In terms of changes in the situation this year, researchers at ANBOUND believe that whether and when Japan’s monetary policy will shift will be the biggest “black swan” in global finance in 2023, and the biggest uncertain policy factor facing the global economy this year. As far as other major economies are concerned, with inflation gradually peaking, the Fed’s rate hikes have moderated, and the future is just a question of when to end the rate hikes, which may lead to a slowdown or even a small recession in the U.S. economy. The situation in Europe is also becoming more obvious. In the case of a prolonged conflict between Russia and Ukraine, the magnitude of the recession in Europe will be deeper, and the process and intensity of its rate hikes will be more moderate. For China, in order to promote economic recovery, monetary policy will promote marginal easing on the basis of maintaining prudence. In other major economies, the development trend is clear, yet Japan’s policy changes become difficult to figure out, especially in December last year, the unexpected move for Japan to relax the upper limit of the yield curve has caused the market to worry that there will be more shock to the international financial markets.
Final analysis conclusion:
The Bank of Japan’s unchanged loose monetary policy will not alleviate the pressure of inflation and economic recession, and the market will be worried because of policy uncertainty, which will become the biggest variability in 2023. Regardless if Japan changes the policy or when it does that, this will impact the global financial market. In particular, the countries in the Asia-Pacific region that are closely connected with it will be even more negatively affected by the shift.
Wei Hongxu is a researcher at ANBOUND