At its July 31 policy meeting, the Bank of Japan (BoJ) raised its policy rate by 15 basis points (bps), in line with our out-of-consensus call. While most market participants flagged the risk of a hike in this meeting, the consensus was to stand pat on rates. The other important decision was the announcement on the paring back in Japanese government bond (JGB) purchases; the central bank had given forward guidance of this action in June.
The BoJ announcement included:
- Raising the short-term interest rate to 0.25% from the current 0%-0.1% by a 7-2 majority vote.
- Cutting its monthly JGB purchases to ¥5.3 trillion in August–September from ¥5.7 trillion in July. It plans to taper by ¥0.4 trillion each quarter thereafter, to ¥2.9 trillion by the first quarter of 2026 (a 7%-8% balance-sheet reduction in two years). This was a unanimous decision.
- There will be an interim assessment of the tapering plan at the June 2025 meeting, but the bank will make “nimble responses,” if necessary, as per the economic reality on the ground.
- The BoJ revised its gross domestic product forecast downward for fiscal year 2024 (ending March 2024) to 0.6% from 0.8% previously. Its forecast for the core Consumer Price Index (CPI) was also adjusted lower to 2.5% but was raised to 2.1% for fiscal year 2025 (ending March 2025). Core-core (stripping out fresh food and energy) was left unchanged roughly around the 2% mark for the next three years.
In his post-meeting press conference, Governor Kazuo Ueda said that a weak yen was a risk for further upside in inflation and that wages and prices were moving sufficiently toward the BoJ’s goal. On the question of weak growth and in particular private consumption, he said that wage growth should support consumption and that data still points to it being on solid footing. He outlined that real rates were still very much negative, and that the impact of the hike on the economy will be manageable. On future rate hikes, Governor Ueda cautioned on being data-dependent.
We are aware wage growth was a primary cause for the BoJ’s rate move. Not only have larger companies shown stronger signs of wage growth in the annual spring wage negotiations, hard data is now reflecting the increases. Scheduled full-time pay for the same sample base has stayed above 2% since September 2023, hitting a record high of 2.7% in May 2024. This trend is expected to remain for the coming months. Smaller firms also continue to feel pressures from labor shortages, according to BoJ’s Tankan survey, which will prompt them to raise wages sufficiently as well.
The other deciding factor for the BoJ was yen weakness. Governor Ueda went out to state the yen’s slide will pose upside risks to inflation. Import prices have been trending up since late last year but turned positive on an annual change basis starting February. It is already at 9.5% year/year in June. Import price rises tend to impact inflation with a six-month lag, indicating that the yen’s persistent weakness could cause sticky inflation going forward. Food makes up close to 10% of Japan’s total goods imports. Imports account for close to 90% of its total energy needs.1
We stick to our earlier assessment of one more rate hike this year (25 bps) in the fourth quarter. There was confidence in the growth-inflation dynamics in Ueda’s comments with BoJ forecasts for inflation barely changed from the April assessment. Real yields and real policy rates remain low, allowing the BoJ to hike while being supportive of economic expansion. While the yen’s recent strength is welcome, US Treasury yields were the main driver. We therefore see the yen’s immediate outlook very much dominated by overseas factors, including the Federal Reserve’s moves.
However, our key takeaway is that the BoJ is wary of currency weakness and its impact on inflationary expectations. It is also taking decisions based on economic fundamentals. Governor Ueda said 0.50% is not the ceiling for the policy rate, even though the market seems to think it is. We view this as a clear indication that further rate hikes cannot be ruled out even beyond the one later this year. Our outlook in this regard is more aggressive than market expectations currently, factoring in four additional rate hikes next year.
All in all, we think the BoJ has delivered on both fronts in its July policy meeting. By hiking rates even as many see growth to be shaky, it has tried to fight off allegations of falling behind the curve.
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1. Source: Center for Strategic and International Studies. As of May 22, 2024.
