How long will Japan's Central Bank stick to sub-zero interest rates?

In our latest insight piece, we examine the monetary policy of the Bank of Japan—the only major central bank still with negative interest rates.

The Bank of Japan (BoJ) is currently the only major central bank with negative interest rates, and is one of the few not to have engaged in monetary tightening this year. Even the perennially dovish Swiss National Bank—which held its policy rate at the world’s lowest level of -0.75% from January 2015 to mid-2022—has since moved rates back into positive territory in order to ward off inflation. 

Japan’s reluctance to follow the monetary crowd stems from a long history of excessively low price pressures. Between 2015 and 2021, inflation averaged a measly 0.3%, well below the BoJ’s 2% target. In 2016 and 2021, prices actually declined in annual terms. While much of today’s focus is on the damaging impact of high inflation on households’ purchasing power, overly low price pressures also pose problems: They can reduce the scope for monetary policy, hurt banks’ profitability, cause consumers to delay spending and increase real debt burdens.   

Thus, in keeping its policy rate in negative territory for a prolonged period, the Bank hopes to ward off these problems by jumpstarting a durable uptick in inflation. It is having some success—the inflation rate rose to an over three-decade high in October, and the Bank commented that inflation expectations had risen.  

However, higher inflation and inflation expectations are not forecast to lead the BoJ to abandon negative rates any time soon. While the Bank shocked markets by raising the cap on bond yields at its December meeting, the policy rate remained at -0.1%, and the Consensus of our analysts is for rates to remain below zero throughout our forecast horizon to 2027. The recent rise in price pressures is not expected to last, and our analysts expect inflation to fall back below 1% in the coming years on subdued demand, necessitating an ongoing ultra-accommodative monetary stance.  

That said, the Bank’s last meeting proves it can be unpredictable and is willing to contradict previous guidance. This suggests rates moving into positive territory is not beyond the realms of possibility—particularly if the yen resumes its downward trend and price pressures continue to intensify. 

Insights from Our Analyst Network

On the outlook, analysts at the EIU said: 

“Surging commodity prices have remained the main underpinning factors behind Japan's firming inflation and their effects are likely to subside in 2023 as global commodity prices stabilise. The yen has recently regained some ground against the US dollar as a result of slowing monetary policy tightening in the US. Both trends suggest that the BOJ will stick to its ultra-accommodative policy stance throughout 2023 to support employment and economic growth.” 

Regarding the surprise December policy change, ING’s Min Joo Kang said: 

“We think Governor Kuroda is trying to pave the way for policy normalisation before stepping down. A policy shift immediately after the leadership change is difficult and could miss the opportune time to end the decades-long ultra-low policy. He may be right that monetary policy should remain accommodative until a stable 2% inflation target is met and that the policy review is not needed in the short term. But, with today's tweak, his successor will have more flexibility to deploy monetary policy in the future. We also expect that the BoJ will maintain its policy balance rate at -0.1% for a while.” 

 

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Author: Oliver Reynolds, Economist

Date: December 23, 2022