Japan ends its negative interest-rate policy

The Bank of Japan (BoJ) ended its negative interest rate policy (NIRP) and raised rates by 10 basis points to a range of 0.0%–0.1% on March 19, 2024. This decision signals policymakers’ confidence in their deflation fight. The prolonged period of low and negative interest rates in Japan has put downward pressure on the USD-JPY exchange rate. It also encouraged Japanese investors to buy higher yielding foreign assets and created the right environment for a carry trade—borrowing Japanese yen to invest in higher yielding currencies.

The impact of the policy change on the USD-JPY rate is likely to be gradual given that it was well telegraphed. Consensus expectations are for a slow rise in interest rates to 0.25% by the end of 2024.¹ Higher interest rates and rising inflation expectations are positive for the Japanese equity market.

The extended period of low and negative interest rates has led to a significant increase in the carry trade. Over the past three years, Japanese yen loans to foreign investors have increased by US$460 billion to US$1.8 trillion.² Conversely, yen weakness has increased the value of overseas investment income received by Japanese investors by US$233 billion to US$551 billion over the same period.³Significant yen strength could reduce these flows, leading to increased volatility in global bond and equity markets.

The implications of the interest-rate increase for the Japanese equity market are positive. A return of modest inflation creates a tailwind for corporate earnings, potentially restarting the investment cycle. For households, the end of falling goods prices may release pent-up demand. Foreign investor flows are also an important market driver, as can be seen in the chart below.

Exhibit 1: Foreigners Are the Marginal Drivers of the Japanese Equity Market

We are positive on Japanese banks, industrials and consumer discretionary companies. Banks are expected to see improved profitability as net interest margins and loan growth increase. Industrials may benefit from a revival in investment. Consumer discretionary companies are beneficiaries of rising wages and a return of pricing power.

While we acknowledge the positives, we are monitoring the downside risks associated with the end of NIRP. We are focusing on the USD-JPY exchange in case of a significant move lower. Such an event could lead to a sharp fall in the US Treasury market as Japanese investors repatriate their US bond market investments. International equity markets could also come under downward pressure if the unwinding of the carry trade leads to the sale of equities by Japanese investors.

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1. Source: Bloomberg, March 19, 2024.

2. Source:  Ministry of Finance Japan. December 31, 2023.

3. Ibid.