The Bank of Japan’s decision to leave interest rates unchanged on Tuesday (December 19) has more to do with events in 1999 than 2023.
Twenty-four years ago, the BOJ became the first major central bank to slash borrowing costs to zero. Over the next two years, in 2000 and 2001, it pioneered quantitative easing (QE).
Two-plus decades of free money has a way of warping economic dynamics. Over time, Japan gave new meaning to the concept of “economic capture” as the public and private sectors grew dependent upon QE.
This phenomenon more than anything else explains why Governor Kazuo Ueda is keeping the BOJ largely on autopilot. As the yen surges in anticipation of a BOJ “tapering,” Japan Inc is already nervously on alert and announcing downward revisions to earnings guidance.
This is fast removing the last of the risk tolerance that Ueda’s team might have had since April, when he took the helm. Back then, expectations were high that the BOJ would exit QE.
Instead, Ueda’s team made some minor tweaks to yield levels, but zero steps in the way of monetary tightening. In doing so, the BOJ missed its window to begin normalizing Japan’s rate environment.
More recently, the economy contracted 2.9% in the July-September period from the previous quarter. This is fanning fears Asia’s second-biggest economy is in recession as China slows and elevated US yields crimp global demand.
Add in the yen’s surge and it’s hard to see Ueda thinking now is an opportune moment to begin a pivot away from QE. (The yen declined 1% today on the BOJ’s decision to hold rates steady.)
That’s especially so given the BOJ’s policies these past 10 years. Since then, the central bank supersized its balance sheet in ways no other Group of Seven nation institution ever had.
Taking a more aggressive approach to ending deflation was exactly what Ueda’s predecessor, Haruhiko Kuroda, was hired to do. In 2013, then-prime minister Shinzo Abe tapped Kuroda to grease the skids for history’s greatest monetary onslaught.
Kuroda didn’t disappoint. He cornered the government bond market and gorged on stocks via exchange-traded funds. By 2018, the BOJ’s balance sheet was bigger than Japan’s US$4.8 trillion economy. The BOJ also became the top holder of Nikkei Stock Average and Topix index stocks.
But now that Japan is veering toward another recession, the question is whether the economy can withstand higher borrowing costs.
“The recent run of data has left the Bank of Japan in a difficult spot,” says Stefan Angrick, senior economist at Moody’s Analytics.
Angrick adds that “private consumption is treading water as wage gains trail inflation and employment conditions soften. Exports, which benefited from a rebound in car shipments and foreign tourism early in 2023, have been broadly trending sideways as weak global demand has capped growth.”
At the same time, GDP in the third quarter disappointed. Fresh fiscal support will keep the economy from sinking. “But,” Angrick says, “we don’t expect output to see major gains until the middle of 2024 as domestic and external demand stay on hold throughout the first half.”
And now, the BOJ is essentially trapped. Kuroda could have at least set the stage for exiting QE. On December 20, 2022, he tested the financial waters by letting 10-year yields rise as high as 0.5%. The moves sent shockwaves across global markets and the yen skyrocketed.
“With extremely high uncertainties surrounding economies and financial markets at home and abroad, the Bank will patiently continue with monetary easing, while nimbly responding to developments in economic activity and prices, as well as financial conditions,” the BOJ said.
Katsutoshi Inadome, senior strategist at SuMi TRUST, says “we expect” a policy “change is very likely next year. We believe it is likely the BOJ will raise interest rates in 2024″ after the central bank gets “a clearer view of forthcoming wage increases.”
Inadome adds that the BOJ “doesn’t want to start hiking at the same time the US begins cutting, so ideally it wants to begin its own policy changes before the US switches its policy.”
To be sure, Kuroda could have at least set the stage for an exit from QE. On December 20, 2022, he tested the financial waters by letting 10-year yields rise as high as 0.5%. The move sent shockwaves across global markets and the yen skyrocketing.
Kuroda never tried again. Between December and April, when he retired, Kuroda avoided any notable steps that might unnerve markets. Basically, Kuroda punted the hard decisions forward so that Ueda could make them.
Since then, Team Ueda let 10-year yields top 0.5% in July. Once markets registered their shock, the BOJ spent the next several days racing to buy assets to communicate no big changes were afoot. The same in October, when the BOJ let yields top 1%.
It’s a pattern that’s played out since 1999 more times than economists can count. And one that’s now limiting the BOJ’s options.
The yen’s powerful rally these last 10 days was driven more by events in Washington than Tokyo. As the US Federal Reserve signaled a likely end to its most aggressive tightening cycle since the mid-1990s, the dollar fell.
As the yen rose, rather innocuous comments by Ueda about the BOJ keeping its options open accelerated the yen’s ascent.
Now, Ueda finds himself in an impossible place — between global markets clamoring for action and domestic tensions telling him this isn’t the moment.
“A hawkish signal from the BOJ has the potential to push the US dollar to the yen below the 140 level, even with prevailing oversold conditions,” says Ipek Ozkardeskaya, senior analyst at Swissquote Bandank. “Conversely, should the BOJ disappoint the market once more, any price rallies could draw the attention of top sellers.”
Among the tensions with which the BOJ is contending: the lowest approval ratings of Prime Minister Fumio Kishida’s two-plus year reign.
Kishida’s 17% support rate makes US President Joe Biden almost seem popular. It reflects both political scandals and inflation outpacing both GDP and wage growth. That Japan may be in a recession hardly helps.
Though the BOJ is technically independent, Kishida’s ruling Liberal Democratic Party (LDP) knows how to make life difficult for hawkish BOJ governors. This dynamic often has the BOJ pulling punches to avoid controversy.
The China factor is its own wildcard. With China growing the slowest in 30 years and the property sector in chaos, Japan has reason to worry Asia’s biggest economy will be exporting deflation in 2024.
Virtually everyone agrees the BOJ must begin normalizing interest rates as soon as possible. Not only have 24 years of zero rates warped credit markets, but they have also deadened the “animal spirits” needed to reinvigorate Japanese innovation and competitiveness.
But it’s hard to imagine the process beginning with the threat of more US Fed rate hikes hovering over Japan Inc. Despite widespread expectations that the Fed is done tightening, US inflation remains well above Tokyo’s 2% comfort zone amid historically tight labor markets.
Japan has the opposite challenge. The big question on Ueda’s mind is being confident he’s “gathered sufficient evidence of a virtuous wage-price cycle,” says currency strategist Carol Kong at the Commonwealth Bank of Australia.
Japanese consumer prices rose 2.9% in October from a year earlier. Though down from a 4.2% rate in January, a 41-year high, inflation has now increased for at least 17 consecutive months.
Worse, it’s the “bad” kind of inflation — imported thanks to elevated energy and food prices, not organic pressures at home.
Over the last two-plus decades of QE — and especially the last 10 years — ultraloose BOJ policies sought to generate “demand-pull” inflation as strong consumption drove companies to hike prices and fatten paychecks.
Instead, Japan’s inflation is of the “cost-push” variety. It owes far more to Vladimir Putin’s Ukraine invasion than BOJ easing. This is exactly the opposite of what Ueda’s predecessor Kuroda intended between 2013 and 2023.
At the same time, surveys show that Japan’s 126 million-person population economy isn’t enjoying this “victory” over deflation. Prices are rising faster than wages, an unwelcome dynamic that’s hurting household confidence.
This tension explains why Kishida’s approval numbers are mired in the low 40s, at best. Speaking at the United Nations General Assembly meeting recently, Kishida described the economy as “currently still not fully stable.”
He pledged that Tokyo will unveil “measures to counter inflation” and “social measures to counter declining population.”
It’s a rough political environment for Ueda to navigate. But it’s one created by the events of 1999. And it suggests the BOJ will hold rates near zero longer than many investors realize.
Follow William Pesek on X, formerly Twitter, at @WilliamPesek