Takahide Kiuchi’s View - Insight into Economic Trends: Making 2023 a Year of Change in Monetary Policy
Jan. 13, 2023
In December last year, the Bank of Japan (“BOJ”) suddenly decided to take measures to loosen yield curve control (“YCC”) by increasing the allowable range of volatility in 10-year Japanese Government Bond (JGB) yields from ±0.25% to ±0.5%. I welcome this measure to correct the rigid monetary policy that has created problems such as the rapid depreciation of the yen. However, financial markets took this as a “substantial interest rate hike,” and the growing expectation that the BOJ will proceed with policy revisions all at once caused turmoil in financial markets.
What is the background behind the sudden policy revision?
Since the BOJ introduced the YCC, which targets the 10-year JGB yield, in September 2016, the BOJ has been gradually increasing the range of yield volatility. It can be said that the current move is an extension of such measures. Since the BOJ has not changed its target for 10-year JGB yields from “around 0%,” it is clear that the latest measures are not a formal interest rate hike (i.e., a policy rate hike).
However, it is not surprising that financial markets took this as a “substantial interest rate hike.” Before this, the BOJ had clearly stated that allowing yields on long-term government bonds to rise by increasing their volatility would be tantamount to raising interest rates, and since this would have an adverse effect on the economy, it would not be implemented. However, since the BOJ suddenly implemented a measure that it had strongly denied, and further explained that this was aimed at improving the functioning of financial markets, was not a rate hike, and would have no adverse effect on the economy, many people are presumably unconvinced.
When implementing policy revisions, the BOJ often does not reveal its true aims. Since last spring, the BOJ has been the subject of strong criticism by businesses and the public for its rigid monetary policy management, which has accelerated the depreciation of the yen and pushed up prices, and its relations with the government would appear to have worsened.
From this point of view, the current measure is likely aimed at restoring these relationships. Additionally, it seems that the measure was also intended to facilitate the transition to the new administration by anticipating the more explicit policy flexibility and normalization measures that are expected to be implemented under the next governor, who will take office in April of this year.
However, it is possible that current Governor Kuroda himself was not necessarily enthusiastic about this policy revision and finally accepted it at the last minute after strong persuasion from the secretariat. For Governor Kuroda, who wants to stay true to his conviction that he will not retreat from his relaxed stance toward price stability of 2% during his term of office, his policy of continued monetary easing has been maintained under these current measures, and he has saved face. One might say that Governor Kuroda has made something of a reputation for himself with this.
Meanwhile, the secretariat, wishing to improve its deteriorating relations with the government and the public in order toto continue to be involved in policy management under the new administration of the next governor, has reaped some benefit in that it has gained a foothold in repairing relations by promoting a loosened policy.
Achieving the 2% price target will be extremely difficult.
Regardless of who is appointed as the next governor, it is likely that under the new administration, the BOJ’s secretariat will lead the process of loosening monetary policy and normalization. In doing so, the obstacle to normalization will be the 2% price target, which is extremely difficult to achieve.
When the BOJ clearly transitions away from its exceptional monetary easing measures, which have been in place for 10 years, there are two possible scenarios: first, the BOJ may implement the measures in response to the achievement of the 2% price target coming into view; second, the BOJ may implement the measures after separating monetary policy management from the price target by repositioning the 2% price target as a long-term target or something similar, even if achieving the 2% price target is not in sight. In reality, the first possibility is extremely unlikely, and normalization measures will probably be initiated in the second form.
Consumer price inflation (excluding fresh food) in December last year is estimated to have reached around +4.0% year-on-year. However, this was caused by soaring food and energy prices overseas combined with the impact of the yen’s depreciation, and excluding these effects, the increase is estimated to be in the mid-1% range. Achieving a stable price inflation rate of 2% is probably still difficult. By the end of this year, consumer prices (excluding fresh food) are expected to fall to the mid-1% range year-on-year.
In addition, the impact of last year’s substantial increase in the rate of consumer inflation is expected to drive up the rate of wage increases this year. The base wage increase (“base up”), not including regular wage increases, is expected to reach a little over 1%, up from the mid-0% range last year. This is far short of the 3% base wage increase that the BOJ has set as the rate of wage growth consistent with the achievement of its 2% price target.
Furthermore, with the situation in overseas economies becoming more severe this year and the yen strengthening again, there is a possibility that the economy will deteriorate quickly. If this happens, companies will generally become more cautious about raising wages, and the base wage increase next year will again fall to the 0% level. Thus, price inflation exceeding 2% is likely to be transitory, and the upward swing in this year’s wage growth rate is also likely to be limited to one year. The two will increase synergistically, and the prospects for achieving a stable 2% inflation rate are arguably rather poor.
Will the joint statement by the government and the BOJ be revised?
In order for the BOJ to proceed with normalization measures, such as removing negative interest rates, it will first be necessary to revise the 2% price target to a more realistic target, such as repositioning it as a long-term target, and to separate monetary policy management from the price target. If specific policy changes, such as removing negative interest rates, are “hard” policy revisions, then the repositioning of the 2% price target would be a “soft” policy (strategy) revision.
A change in the positioning of the 2% price target could occur, even immediately after the change of governors in April, through a revision of the 2013 Joint Statement of the Government and the Bank of Japan, which describes the arrangements between the government and the BOJ regarding price targets. The government may want to implement this under its own leadership.
However, because a government-led amendment to the Joint Statement would set a precedent that any policy change would require prior government approval, the BOJ may wish to reposition the 2% price target on its own.
In the first place, the Joint Statement was likely not meant to suggest that the BOJ’s goal was to achieve the 2% price target through monetary policy alone. It was based on the assumption that a wide range of economic actors, including the government and businesses, would work to increase the growth potential of the economy, and that these efforts would eventually be successful, resulting in a significant increase in the trend of the rate of price inflation.
From this point of view, this is in effect a medium- to long-term target, and even without going so far as to revise the Joint Statement, the BOJ will be able to separate monetary policy management from the price target and proceed with normalization measures in earnest simply by explaining the original meaning of the 2% price target in the joint statement.
Full normalization, including removal of negative interest rates, may be postponed until mid-2024 or later.
Such “soft” policy (strategy) revisions may well be implemented this year under the new administration. However, a global economic downturn, a decline in the inflation rate, a stronger yen, and the emergence of the expectation of monetary easing in the U.S. are expected to occur in the first half of the year, in which case the implementation of “hard” policy revisions and normalization measures, such as removing negative interest rates, will likely be postponed until mid-2024 or later.
Meanwhile, if the upward pressure on yields on long-term JGBs does not subside with the prospect of policy revisions and the BOJ is forced to continue its massive purchases of long-term JGBs to keep yields under control, the BOJ may be forced to further widen the YCC’s 10-year JGB yield volatility range to ±0.75% and allow another rise in yields on long-term JGBs by the end of this year. However, since the YCC itself is expected to play a new role in preventing the risk of a significant rise in yields on long-term JGBs when negative interest rates are removed in the future, it is expected that the framework will be maintained for the time being and eliminated after the removal of negative interest rates.