Japan’s monetary policy underwent a historic shift last month under the leadership of Bank of Japan Gov. Kazuo Ueda, who marks one year on the job on Tuesday, as the central bank decided to scrap negative interest rates to implement its first rate hike in 17 years.
The move highlights how the BOJ is finally taking a step away from its decadelong aggressive monetary easing, which was rolled out by Ueda’s predecessor, Haruhiko Kuroda.
Looking back at his first year, some central bank watchers have praised Ueda for the way in which he has navigated the transition toward monetary policy normalization. But they also pointed out that there are mounting challenges ahead for the Ueda-led BOJ as Japan begins to contend with positive interest rates.
“I believe Mr. Ueda managed the policy really well and it was better than we expected,” said Saisuke Sakai, senior economist at Mizuho Research & Technologies.
On March 19, the BOJ decided to end its negative short-term interest rates for some banks' excess funds at the central bank and set a new target of zero percent to 0.1% for the overnight call rate.
The BOJ also announced a termination of its yield curve control (YCC) program, which was designed to keep 10-year Japanese Government Bond yields to around zero percent with a 1% loose upper cap through the purchase of JGBs. The bank also stopped purchasing exchange-traded funds and real estate investment trusts known as J-REIT.
These unorthodox measures were symbolic components of Kuroda’s monetary stimulus, but they also made the monetary policy setting more complicated.
Since Ueda's inauguration, unwinding these policy tools, which were also causing some side effects including distorting market functions, had been a major challenge, as changes made to them directly impact the market and could have caused a spike in long-term rates.
What was remarkable about Ueda’s management is that the BOJ was able to end those policies without sparking market turmoil, Sakai said.
“The important point is that Mr. Ueda made some preparations in the past year to create the situation where (the BOJ’s decision last month) would not” stir market confusion, Sakai added.
In an apparent attempt to blunt some of the side effects and prepare for normalization, the BOJ altered the YCC program last July to adopt greater flexibility in its operation, before making further adjustments last October to allow 10-year JGB yields to increase above 1%.
The YCC policy was widely seen as unsustainable and creating negative side effects, with the BOJ’s purchasing of JGBs distorting the bond market. These tweaks in July and October actually reduced the YCC program to a mere formality.
“I was concerned about the ending of the YCC policy, since it would have been really difficult to do it” without causing market confusion, Sakai said, citing the experience of the Reserve Bank of Australia three years ago.
In November 2021, the Australian central bank ended its YCC policy, under which it had set a 0.1% target for the benchmark three-year government bond, after losing control of this rate target when investors attempted to test the peg and push up the yield.
In its policy review report, the RBA said “the target was met for the bulk of the period, but the exit in late 2021 was disorderly and associated with bond market volatility and some dislocation in the market.
“This experience caused some reputational damage to the bank.”
Yet in the BOJ’s case, “it has been able to end (its unconventional policies) smoothly, which I think deserves a positive appraisal,” said Tsuyoshi Ueno, senior economist at NLI Research Institute.
Meanwhile, external factors beyond the control of the BOJ actually worked as a tailwind for normalization.
For instance, the BOJ was able to proceed with the move due to sharp wage hikes in spring pay negotiations.
According to Japan’s largest labor organization, Rengo, the preliminary figure for the average hike stood at a 33-year high of 5.24%. That is considerably higher than last year’s preliminary figure of 3.7%, which at the time was already a historic high.
The robust wage hikes were mainly due to recent high inflation that was pushed up by rising import costs and the weakening of the yen, while serious labor shortages also prompted many firms to offer higher salaries.
The central bank said in a statement after its March policy meeting that a healthy price-wage cycle is more evident now, and “it came in sight that the price stability target of 2% would be achieved in a sustainable and stable manner” in the coming years.
While Ueda may have gotten off to a good start, the BOJ will likely face more challenges from now on in its attempt to normalize its monetary policy now that Japan no longer has negative interest rates.
In a news conference last month after the policy meeting, Ueda said the unorthodox measures had fulfilled their roles and that the BOJ will be running a “normal monetary policy” with its primary policy instrument being a control of short-term interest rates.
Economists, however, said that managing short-term rates or implementing further rate hikes will be tough, as they would require the central bank to balance various factors.
The scrapping of negative rates may be seen as historic, but it only lifted rates from minus 0.1% to zero, and the actual economic impact has been limited so far. The rate hike this time has not affected short-term prime rates — the benchmark used for floating-rate mortgages — set by major private banks.
Yet if the BOJ were to introduce further rate hikes, it would likely bring about bigger economic implications.
Although prices and wages may be growing, “consumption still remains weak, so it is still unclear whether a virtuous price-wage cycle is really happening, while the yen continues to be weak, damaging households,” Sakai said.
Under such circumstances, rate hikes may be effective in strengthening the yen’s value but they would lead to higher mortgage rates that would affect many households.
Thus, politicians will likely watch the central bank’s moves more closely to determine their impact on the economy, so “the BOJ would have to take the political factor into consideration to a certain degree,” Sakai said.
“I believe raising rates in the positive territory would be a bit different from (a rate hike from negative territory). It could be a restraining factor for the government’s spending policy, so the ability to communicate with the market will be more important,” Ueno said.
When it comes to communication, Ueda explains and answers questions at news conferences and parliamentary sessions in a logical and careful manner, but he does not really give specifics, making it hard for market participants to predict the outlook, Ueno said.
For instance, Ueda had said the BOJ would consider shifting its policy if its stable and sustainable 2% inflation target is in sight, but he was vague about the specific conditions, Ueno said. Ueda has also not given any hints of when an additional rate hike would take place, he added.
Pointing out an example of the dot plot released by the U.S. Federal Reserve, which shows Fed officials’ projections for its key short-term interest rate, Ueno said, “I feel there should be some mechanism that helps market participants predict the policy outlook.”
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