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Japan Monetary Policy March 2023

Japan: Economists see new Central Bank governor Ueda tweaking yields but not interest rates

—New governor Kazuo Ueda is to take office on 9 April.

—Our panelists see Ueda adjusting yield curve control in Q2 2023—potentially as soon as the 27–28 April meeting—but leaving the policy rate untouched until H2 2024.

—Upside risks to policy rate forecasts are posed by stronger-than-expected wage growth.

What happened: On 10 March, the Japanese Parliament voted for Kazuo Ueda to become the Bank of Japan’s (BoJ) new governor. Ueda will take the reins from current governor Haruhiko Kuroda on 9 April and chair his first BoJ policy meeting on 27–28 April.

What will happen: It appears likely that Ueda will loosen YCC—which currently allows 10-year bond yields to move in the range of -0.50–0.50%—as the government bond market has become increasingly dysfunctional. For the first time in history, in September, the BoJ owned more than 50% of outstanding Japanese government debt. In December, the latest month for which data is available, the BoJ announced that its share had risen to 52%. As a result, liquidity in the bond market has been suppressed, and the market now only has a limited role in determining the price of government debt. Allowing bond yields to move higher would also be attractive as it would be a small step towards normalizing monetary policy. In contrast, changing the policy rate would mark a dramatic shift in monetary policy after seven years of negative rates.

Several factors suggest that Ueda is likely to prefer a gradual approach to monetary policy normalization. First and foremost, even with negative rates, the BoJ should fail to reach its central objective of 2.0% inflation in the medium run. According to our Consensus Forecast, inflation is set to fall below the 2.0% target in Q4 2023 and continue falling thereafter. The shocks that have brought inflation to a more than 40-year high, such as elevated energy prices, are likely to fizzle out in the medium term. Even if the government makes changes to the inflation target, the specter of deflation—which has haunted Japan for decades—is likely to deter Ueda from hiking rates in the short term.

Second is Ueda’s track record and recent comments. Ueda was formerly on the BoJ’s board between 1998 and 2005, and in 2000 dissented against the BoJ’s decision to end its zero-interest rate policy. Moreover, in a parliamentary hearing in February, Ueda made three dovish comments: He said that underlying inflation needs to increase significantly before changes to monetary policy are made; that the benefits of the BoJ’s stimulus outweighed its negatives; and that he was in no rush to change the BoJ’s 2.0% inflation target.

Third, recent instability in the global banking sector could reduce the interest rate hikes required of other major central banks, thus reducing pressure on the yen and the need for the BoJ to move its policy rate out of negative territory.

Risks to the outlook: That said, wage inflation is an upside risk to the policy rate. The annual shunto wage negotiations were concluded by trade unions and employers this March. According to Bloomberg, key unions won a 3.8% pay increase, the highest since 1993, above economists’ expectations and in excess of the 3% that the BoJ’s outgoing Governor Kuroda has said is necessary for the BoJ to normalize policy.

On the flipside, recent banking turmoil could potentially encourage the BoJ to make no change to YCC for the time being. Part of the reason for the collapse of Silicon Valley Bank (SVB) was its purchase of large quantities of long-term government bonds. With interest rates increasing, the price of the bonds—which is inverse to their yield—slumped and left a gaping hole in SVB’s balance sheet, with a subsequent bank run delivering the coup de grâce. The BoJ could be concerned that raising the YCC could cause similar problems for Japanese banks, given current market uncertainty and the fact that they are already nursing unrealized losses on foreign bonds. In addition, Japanese 10-year yields have fallen since the collapse of SVB to below the 0.50% upper bound, reducing the pressure on the BoJ to change YCC.

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