The Strategist

Turning the Tide: The Bank of Japan’s prudent shift away from negative interest rates

The Bank of Japan (BoJ) has taken an important step in the right direction, even if the markets were ultimately disappointed, as the performance of the Japanese yen (JPY) shows. It fell both before and after the monetary policy meeting. However, the value of the JPY is expected to improve as the year progresses. This positive outlook is not only due to the measures taken by the BoJ, but also to the opposite steps taken by the US Federal Reserve, which is considering easing its monetary policy.

Sebastian Petric, LGT Senior FX Strategist
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In a notable development, the Bank of Japan has made a pivotal decision to increase the cost of borrowing for the first time in seventeen years. This move marks a significant shift from the previously maintained key interest rate of -0.1% to a new range between 0% and 0.1%. The adjustment arises in the context of a sharp increase in wages, following a rise in consumer prices. The initial decision to reduce the rate below zero in 2016 was aimed at stimulating Japan’s stagnating economy. With this recent hike, the phenomenon of negative interest rates has been abolished globally.

In addition, the BoJ has decided to discontinue its yield curve control policy. This strategy involved the purchasing of Japanese government bonds to regulate interest rates. That being said, in maintaining its commitment to economic stability, the BoJ has indicated that it will continue purchasing government bonds in similar volumes as before, with a readiness to escalate purchases should yields rise sharply. This approach indicates a cautious stance, avoiding overly aggressive policy shifts, which was reflected in the Japanese yen's subsequent reaction.

Strong wage increases has put pressure on the BoJ

Expectations had been mounting for the BoJ to raise rates, especially following the appointment of Governor Kazuo Ueda in April of the previous year. The impetus for this rate hike was significantly influenced by major corporations’ decisions to increase wages, thereby aiding workers in coping with the escalating cost of living. Remarkably, this month saw Japan’s largest companies agreeing to a wage increase of 5.28%, the most substantial rise in over three decades. Japan’s avoidance of a recession, as indicated by revised official economic growth figures, provided the BoJ with the confidence to proceed with this policy adjustment.

The Japanese yen experienced a weakening both prior to and following the policy meeting. However, there is anticipation that the JPY’s value may enhance later in the year, attributed not only to the BoJ’s actions but also to contrasting movements by the US Federal Reserve. As the Fed is considering interest rate cuts while the BoJ is raising rates, an appreciation of the yen is possible.

Step in the right direction

In our view, the policy shift by the Japanese central bank represents a modest but significant step in the right direction, reflecting a commitment to adapting policy to maintain financial stability.

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