TOKYO — With the Nikkei 225 surging to 34-year highs, the conventional wisdom is that the Bank of Japan (BOJ) now has greater confidence — and political cover — to raise interest rates and end decades of quantitative easing (QE).
But what if the opposite is true? Might the Nikkei boom luring tidal waves of capital toward Tokyo actually dissuade the BOJ from normalizing monetary policy? A walk down memory lane suggests BOJ Governor Kazuo Ueda might be too worried about spoiling the Nikkei’s party to tighten.
Consider the BOJ’s track record of hitting the monetary brakes during stock rallies of the past. Case in point: the central bank’s December 1989 rate hike, which signaled the end of the Nikkei’s most infamous bull run.
No one really knew at that moment, least of all then-BOJ governor Yasushi Mieno, who pulled the fateful trigger on Christmas day. That half-percentage point increase in short-term rates to 4.25% seemed like a rational response to upward inflation pressures at the time.
Even then-finance minister Ryutaro Hashimoto said the increase would help maintain price stability. But years later, when Hashimoto served as prime minister from 1996 to 1998, it was clear that the BOJ’s tightening move marked the top tick of Japan’s “bubble economy” era. And the start of a deflationary nightmare from which Japan is only now starting to recover.
Today, economists know that on December 25, 1989, Mieno’s team pulled out the financial equivalent of a precarious Jenga piece, destabilizing everything above and below. Fair or not, Mieno’s BOJ was roundly criticized for collapsing the stock market and setting Japan’s lost decades in motion.
Granted, the titanically large rallies in real estate and stocks might have been better tamed with macroprudential policy tweaks by the Ministry of Finance and regulators than blunt-force BOJ rate hikes. At the time, though, Tokyo’s politics were going through a unique period of volatility.
In 1989 alone, Japan had three different prime ministers: Noboru Takeshita, Sosuke Uno and Toshiki Kaifu. Distracted elected officials left asset bubble management duties to the BOJ.
Once Mieno retired in 1994, it fell to successor Yasuo Matsushita to deal with the economic fallout. That included mountains of bad loans on bank balance sheets. By the time Matsushita passed the torch to Governor Masaru Hayami in 1998, Japan had already fallen into deflation.
In 1999, Hayami became the first major central bank leader to slash rates to zero. In 2000 and 2001, the Hayami BOJ pioneered quantitative easing, or QE. In 2003, it was Toshihiko Fukui’s turn to manage Japan’s QE experiment.
Fukui decided Japan was ready to rip out the monetary intravenous tubes and ended QE. Then in 2006 and 2007, the Fukui-led BOJ managed to hike official rates twice.
The backlash was fast and furious. Politicians and corporate chieftains groused early and often about Fukui yanking away the proverbial punchbowl.
Yet when the economy slid into recession soon afterward and the Nikkei stumbled, the Tokyo establishment blamed the BOJ for messing up – again.
When Fukui’s replacement arrived in 2008, Masaaki Shirakawa quickly restored QE and returned rates to zero. In 2013, Governor Haruhiko Kuroda arrived to turbocharge QE in hyper-aggressive ways. Kuroda’s BOJ cornered the government bond market and nearly nationalized the stock market, becoming the biggest investor by far.
That sent the yen down 30%, boosting exports and generating record corporate profits. In 2013 alone, the Nikkei surged 57%. In the years since then, ultra-loose BOJ policies, coupled with government efforts to strengthen corporate governance, sent the Nikkei to its current highs. The benchmark is up 45% over the last 12 months.
Yet the market’s current bull run, which began last year, appeared to make the BOJ timid about stepping away from QE.
In December 2022, Kuroda tiptoed up to the line by letting 10-year yields rise as high as 0.5%. Global markets quaked, sending the yen and Japanese yields skyrocketing. Kuroda’s team spent the week after December 20, 2022, racing to make large and unscheduled bond purchases to cap yields. After that, Kuroda didn’t attempt to “taper” again.
Enter Ueda, who grabbed the BOJ’s controls last March. Ueda also tested the waters here and there, letting 10-year rates rise to 1% and beyond. Once again, markets took it badly and the BOJ scrambled to reassure bond traders that no big policy changes were afoot.
Since then, Ueda has avoided any hints that QE might be dismantled, that negative yield policies might be abandoned or that an official rate hike might be in the cards. This, of course, is not how global markets saw the Ueda era going.
As 2024 began, the overwhelming conventional wisdom was that Ueda’s team would be hiking rates by next month. But the fact Japan entered 2024 in recession has made the timing of BOJ tightening a moving target.
Analyst Ipek Ozkardeskaya at FXSteet.com speaks for many when she says “the Bank of Japan is in no rush to hike rates this April.”
Etsuro Honda, former special advisor to Japan’s Cabinet, tells Reuters that “while uncertainty is high, I oppose ending negative rates. It’s too early.” Honda adds that “negative rates are used for inter-bank operations, which apply risk premiums when it comes to corporations where no one’s asking for borrowing with negative rates.”
Earlier this month, BOJ Deputy Governor Shinichi Uchida tamped down expectations for near-term tightening moves. Speaking in the western city of Nara on February 8, Uchida said: “If sustainable and stable achievement of our 2% inflation target comes in sight, the large-scale monetary easing will have fulfilled its role and we’ll explore whether it should be revised.”
Complicating the many “if’s” confronting the BOJ is uncertainty about whether inflation is slowing or accelerating. Japan’s consumer prices slowed less than expected in January, with “core” inflation rising at a 2% rate year on year. On the price trend front, “recent data have been extremely disappointing,” says Stefan Angrick, an economist at Moody’s Analytics.
As Hiroshi Yoshikawa, professor emeritus at the University of Tokyo, tells Bloomberg of Ueda’s plight: “I wish him the best of luck. Financial markets and the government are making the BOJ’s exit into a special event and fixating on if the bank is going to act and when. As the governor in charge of the policy, he may have little choice but to be cautious.”
Many are still betting on the BOJ acting. “This means that inflation remains above the Bank of Japan target, validating market expectations for a rate hike in the first half of the year,” says Francesco Pesole, economist at ING Bank.
This view, however, ignores how the ghosts of 1989 are colliding with the economic uncertainties of 2024 — and, to some extent, the ghosts of the mid-2000s, too. Not only did Japan’s crash in the early 1990s and the resulting bad loan crisis cause deflation — it also pushed the financial system to the brink.
In November 1997, Yamaichi Securities collapsed. The failure of a then-100-year-old Japan Inc icon shook markets everywhere, coming amidst the Asian financial crisis slamming Indonesia, South Korea and Thailand. Japan, punters worried, wasn’t too big to fail, but was too big to save. Thankfully, officials in Tokyo kept the episode from becoming a systemic shock globally.
But that near miss might also be factoring into Ueda’s calculus as he mulls withdrawing liquidity. The year since the demise of Silicon Valley Bank in California has put a spotlight on Japan’s vast network of profit-starved regional banks.
Across this aging nation of 126 million people are 100-plus regional institutions serving less economically vibrant regions. These banks have long been reluctant to consolidate or fully embrace the digitalization trends disrupting the globe.
As the population ages and the corporate exodus to Tokyo accelerates, there’s less demand for loans from rural lenders. And the trauma from 20 years of deflation left mid-size lenders more conservative than ever.
Rather than use BOJ liquidity to increase lending, many regional banks spent the last decade buying government and corporate bonds, leaving balance sheets vulnerable to higher long-term rates.
This pivot will sound familiar to students of last year’s SVB collapse in California. Ueda’s BOJ worries that rate hikes could push some fragile rural lenders toward insolvency as longer-term yields surge, SVB-style.
For these reasons and others, Ueda hasn’t been the maverick some thought the Massachusetts Institute of Technology-trained economist might be. A big one could be the BOJ not wanting to be blamed again for wrecking a bull market in stocks.
As Kei Okamura, portfolio manager of Japanese equities at Neuberger Berman, notes, “we are still at the very beginnings for foreign fund inflows.”
Jean Boivin, a managing director at BlackRock, says “Japan’s equity rally has room to run” and that the market “can best their all-time highs.”
JPMorgan strategist Rie Nishihara adds that the Nikkei boom “will spur corporates to increase growth investment and improve capital efficiency and make institutional and individual investors take more interest.”
If the BOJ is perceived to be the spoiler once again, the risk is that the political empire in Tokyo might strike back.
The extent to which the ruling Liberal Democratic Party’s leadership is unpopular with voters can be seen in the 17% approval rating with which Prime Minister Fumio Kishida entered 2024. The LDP and its actions would surely push back hard on any hints Ueda might shock global markets.
There’s an argument that the feel-good factor from the Nikkei rally could improve Kishida’s support numbers and impart a “wealth effect” that makes businesses and households feel better about the economy.
But the Nikkei’s surge could also be the tail wagging the dog at BOJ headquarters. Remember how wrong the conventional wisdom was about the BOJ last year? It could be even more wrong about what’s afoot in 2024.
Follow William Pesek on X, formerly Twitter, at @WilliamPesek