Macroeconomics: Dovish bank of Japan’s hawkish hint

Dovish Bank of Japan Governor Ueda jolted markets today after noting in a weekend interview in the Yomiuri newspaper that the BoJ may end negative interest rates when its goal of maintaining inflation at its 2% target is in sight.

Source: Bank of Singapore, Bloomberg.

The chart shows the BoJ has kept its deposit rate at -0.10% and capped 10Y bond yields around 0% since 2016. The dovish stance has helped the Nikkei reach 33-year highs above 33,000 in 2023.

However, core inflation has hit four-decade highs over 4% after the shocks of the pandemic and the war in Ukraine as the next chart shows. The BoJ is thus under pressure to start lifting interest rates as inflation is finally becoming entrenched around its 2% goal after three ‘lost’ decades of deflation.

Source: Bank of Singapore, Bloomberg.

Ueda said: ‘‘Once we're convinced Japan will see sustained rises in inflation accompanied by wage growth, there are various options we can take. If we judge that Japan can achieve its inflation target even after ending negative rates, we'll do so’’. Financial markets reacted sharply. 10Y government bond yields hit their highest levels since 2014 at 0.70%, the JPY rallied from 148 to 146 against the USD and the Nikkei fell today.

We think it is still unlikely the BoJ will raise its deposit rate from -0.10% this year as officials will want to see more evidence first that wages will keep rising to ensure inflation stays around the BoJ’s 2% target now. The central bank governor noted: ‘‘While Japan is showing budding positive signs, achievement of our target isn't in sight yet’’.

Ueda observed if was possible for the BoJ to have enough evidence before the end of 2023 that wages will keep increasing in 2024 for the central bank to consider raising interest rates this year: ‘‘We can't rule out the possibility we'll get enough information and data by year-end’’. We think officials, however, will wait to see the annual spring wage round in early 2024 before considering whether to start hiking interest rates in the first half of next year.

We thus see the BoJ staying dovish in 2023 to the benefit of Japan’s equities. However, the hawkish hint is a warning the JPY is likely to rebound strongly when negative interest rates do end in 2024. Our 12-month JPY forecast is 125 against the USD.

This article was first published by Bank of Singapore on September 11, 2023. The Opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of Bank OCBC NISP Private Banking Tbk. or its affiliates.

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