The Bank of Japan (BoJ) has kept its benchmark interest rates unchanged at -0.1% for the duration of the 2 year global rate hike cycle. This stance has surprised some commentators who expected the BoJ to adopt a monetary policy that resembled something closer to the rest of the world. The BoJ’s benchmark rate of -0.1% has been in place since January 2016 – a period of significant global change.
The BoJ stance reflects the reality that Japan does its own thing, plays a long term game and its actions/ inactions rarely have any bearing on what is happening elsewhere in the world. The BoJ has US$1.25trn of reserves affording it considerable flexibility. This is the second highest level of central bank reserves in the world. The Tokyo stockmarket has a very low correlation with other major global markets.
The BoJ monetary policy consists of “YCC” (yield curve control) which allows for 10 year bond yields to rise to 1% – the yield has risen to 0.73% up 0.49% over the last year in response to higher Japanese GDP growth.
In December 2022 when the BoJ lifted the 10 year bond yield limit from 0.5% to 1% it released the BoJ from having to buy Japanese bonds as yields rose to 0.5%. Now as yields approach 1% the ‘YCC’ approach could be tweaked again. YCC also allows the bond market to adjust to the new realities of higher global inflation that Japan will eventually face via its imports bill. Japanese policy is to allow bond yields to rise, without involving a new round of quantitative easing. The “YCC” approach is more of a ‘line in the sand’ than rigid policy, allowing considerable flexibility, as the change in yields over the last year demonstrates:-
The BoJ policy appears to be a non-financial adaptation of a ‘dirty float’. In a ‘dirty float’ a central bank tries to maintain a loose fix with a peg via financial and verbal intervention to catch investors offside, if/ when volatility picks up.
But in this case the BoJ is only using verbal guidance as opposed to central bank intervention or market operations. There does not appear to be even a loose peg or a target rate to the USD. The advantage of a weak ‘dirty float’ is flexibility and this seems to be the BoJ approach here. Cash interest rates have stayed low but bond yields have increased.
During the ‘Abenomics’ period from 2012 to 2020 the Japanese government tried all sorts of methods to boost GDP growth. This included increasing the money supply, quantitative easing (the purchase of government bonds), higher government spending and welfare spending to encourage the birth rate and reforms to the corporate sector.
‘Abenomics’ initially boosted the economy however the initial growth spurt was not sustained. PM Shinzo Abe who lasted a lengthy 8 years as PM stepped down in 2020 then the C-19 pandemic intervened. The new government did host the Tokyo Olympics a year after and adopted a slow and cautious approach to re-opening post C-19.
In 2023 there has been a GDP growth spurt helped by export growth and a weak Yen. Q1 GDP at 3.7% rose to 6.1% in Q2 2023. Over H2 2023 GDP should continue very strong (global factors being equal) with strong incoming tourism and pent up demand being released.
|JAPAN||-0.1% /-0.1%||3%/ 2.9%*||0.5% / 6%||2.5% / 2.7%|
Source: CSS Investments Ltd
The Yen’s weakness against the USD will boost inflationary pressures in oil, food and energy imports especially if the weakness continues. This impact has so far been ignored by the BoJ. In the context of the last five years the Yen’s drop has been severe – USD has risen 31% vs the Yen in that time.
The main beneficiary of Yen depreciation has been an export boom and higher inflation that the Bank of Japan has tacitly encouraged. If the Yen is allowed to rally now, the export recovery could be derailed. Japanese exporters have had a very strong run over the last year.
The Bank of Japan could modestly increase interest rates over the next year however we expect this will not be sufficient to alter the overall policy effect.
Having visited Japan and marvelled at Shinjuku’s skyscrapers and the outstanding scenic beauty of its countryside – it was nevertheless clear to me that Japan is a complicated place, highly professional with lots of rules. Not a place where you would want too much to go wrong. Japan is very much a closed country with negligible immigration and highly entrenched established traditions. Change happens slowly.
This is partly due to the ‘1955 System’ – the Liberal Democratic Party (LDP) has run the Japanese government almost continuously since 1955 with only brief intervals (1993-94) and (2009-2012). The LDP are a moderate, centrist party. They are careful about Japan’s overseas image particularly in Asia as the recent decision of release radioactive sea water from the Tokyo Electric Power nuclear plant proved.
Japan faces considerable structural challenges i.e. the ageing population. At its recent ‘Respect for the Aged Day’ government data revealed Japan had the world’s oldest population with 29.1% above 65 and 10% above 80. Volumes have been written Japan becoming the first country to sell more adult nappies than baby nappies and other anecdotes that point to the implications for Japan of having too few working people. There have also been documentaries on the high portion of young Japanese ‘lying low’ and basically economically inactive.
So far Japan has muddled through these problems, as most countries would – there is not much that can be done about it if immigration policy remains where it is. There does not appear to be broad consensus for significant change.
The best that can be said about the BoJ policy of managed Yen devaluation is its contribution to meaningfully boost GDP – which has been elusive for years. We expect policy tweaks only that would serve to maintain economic momentum.