Governor Ueda interview leads yen to appreciation, long-term yields to rise

In the Tokyo financial market on September 11, the dollar-yen exchange rate swung toward an appreciation of the yen against the dollar. The yen had depreciated to the level of 1USD/147.80 yen in the overseas market last weekend, but then reversed course and climbed almost one full yen. In addition, 10-year JGB yields in the government bond market rose to the 0.7% range. This was the first time since the Bank of Japan moved to tweak its Yield Curve Control (YCC) at the end of July that yields rose to the range of 0.7%. This level hasn’t been seen in nine years and eight months.

What prompted the yen to appreciate in the foreign exchange market and yields to rise in the government bond market was an interview article with BOJ Governor Ueda published in the Yomiuri Shimbun on September 9. His remarks in that article were taken to suggest the possibility of rate hikes coming soon, perhaps even sometime this year, causing a reaction in the financial markets.

Do Ueda’s remarks suggest a rate hike might occur before year’s end?

Governor Ueda stated that the Bank of Japan is currently at the stage of assessing whether the cycle of wages and prices will lead to higher salaries next year, commenting that “there is a non-zero possibility that we will have enough information and data by the end of the year (showing sufficient momentum for wage increases next spring)”. Of all the content in the interview, this remark led speculation to emerge in the financial markets that an interest rate hike would be coming soon.

But if we look at his remarks in their entirety, we can hardly conclude that they are different in tone from the past or are more optimistic toward rate hikes. Other comments such as “The achievement of our price target is not yet in sight. The realization of the price target will only be visible when the virtuous cycle of wages and prices can sustain itself even if monetary easing is stopped”, and “There is still some distance to achieving the price target, and we will persist with our monetary easing”, for instance, are just as cautious about policy revisions as any that have previously been made. The interview as a whole can thus be said to strike a balance.

Two policy revision scenarios

Governor Ueda likely still believes that achieving a stable 2% price target will be difficult to do. However, given that the current program of monetary easing carries the risk of a whole host of side effects, it’s conceivable that has strong intentions toward enacting policy revisions. Now, if the upside risk in inflation were to persist to some degree, it’s possible he would use that as a pretext to declare that the achievement of that price target is now in sight—even if he lacks confidence about it—and embark on a course of policy revisions.

Yet what seems a more likely outcome is that the rate of wage increases resulting from next year’s spring wage negotiations will fail to rise as much as expected, leading the Governor to judge that the price target will be too difficult to achieve in the short term, and that monetary easing will need to be prolonged.

Furthermore, in this scenario, the bank would look to dig in for a long-term battle and make this easing more sustainable by enacting policy revisions aimed specifically at mitigating the side effects causing any impediments. In that case, the Bank of Japan would need to closely watch what happens with the wage negotiations next spring. It would probably still be likely that policy revisions would come next year or thereafter.

If the upside risk of inflation is extreme, it’s also possible that policy revisions will be undertaken before the end of the year following the first scenario, but the chances of that would seem not to be high, as evidenced by Governor Ueda’s phrasing about “a non-zero possibility”.

With YCC tweaking, the Bank of Japan gained a means of reining in the yen’s depreciation

While I believe that Governor Ueda’s most recent remarks do not suggest that chances were high for a rate hike anytime soon, it is nevertheless possible that he was thinking to some extent about reining in the depreciation of the yen. Under the preceding Kuroda administration, there was intense friction between Governor Kuroda, with his insistence on strictly managing YCC, and the government, which was highly vigilant against the yen’s ensuing depreciation, and ultimately the government decided to make a foreign exchange intervention that entailed buying yen and selling dollars.

That said, the Bank of Japan’s policy stance under Governor Ueda is more flexible, and its relationship with the government is also more favorable. Governor Ueda has admitted that the tweaks to YCC in July were a decision made with the exchange rate in mind.

In this situation, a rise in long-term JGB yields of up to 1.0% can now be tolerated. By allowing yields to rise, the bank will be able to shrink the gap in long-term yields between the U.S. and Japan—which has a significant effect on the dollar-yen exchange rate—and thereby curb the yen’s depreciation. These tweaks to YCC have provided the Bank of Japan with a means of reining in the weaking of the yen.

The Bank of Japan has deepened its cooperative relationship with the government, seeking to prevent yen depreciation

Further, as another means for urging long-term JGB yields to go up, there is a kind of “lip service” intervention which implies the possibility of a policy revision. It’s also likely that these latest remarks made by Governor Ueda were of that sort. Moreover, there’s even the possibility that curbing the amount of long-term JGBs that the bank buys could spur on a rise in long-term JGB yields.

With the inauguration of Governor Ueda and the tweaking of YCC, it’s now possible for the government and the Bank of Japan to work together more closely in reining in the yen’s depreciation. This is not the sort of situation we saw last year, when a foreign exchange intervention by the government was the only means available for stopping the yen from weakening.

Given these points, there’s little risk that the yen will continue to depreciate as much as it did last year, and as for whether the value of the yen will fall as far as around 1USD/152JPY, which was the peak of depreciation that year, it still remains to be seen.

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  Takahide Kiuchi

  Executive Economist