Interview article with the Governor leads projected timing for a rate hike to be moved forward

The Bank of Japan will hold a Monetary Policy Meeting on September 21 and 22. Given that at the last meeting held in July, the central bank merely made a tweak to its Yield Curve Control (YCC), few believe it will enact any policy revisions at this next meeting.

In response to a recent interview in the Yomiuri Shimbun, the prospective timing at which the financial markets expected the bank to eliminate its negative interest rate policy was moved forward. According to various questionnaire surveys for economists, most respondents expect to see the negative interest rate policy eliminated next April, followed by more than a few who project it would happen next January. Some even believe it would happen before the end of this year.

However, a reaction to this interview article in the financial markets in the form of a rise in long-term yields, or a policy outlook revision, would probably be something of an overreaction. In the article, 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, and he went on to remark 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)”. Out of everything said in the interview, this remark led speculation to emerge in the financial markets that an interest rate hike would be coming soon.

Next year’s spring wage negotiations of decisive importance; difficult to imagine policy revisions coming any sooner

However, the remark that “there is a non-zero possibility that we will have enough information and data by the end of the year” means, just as the words suggest, that the possibility of that is not zero, while probably indicating that the likelihood is quite low. At the Governor’s press conference on the 22nd, if asked about his real intentions in this interview, Governor Ueda could be expected to double down and stress once more that there will be no changes in the bank’s policy stance. The consequence of that would be to push back the prospective timing of a rate hike, and it is foreseeable that long-term yields would fall and that the yen would only depreciate somewhat further.

The Bank of Japan is currently watching price and wage trends very closely, and the chance that it will enact any full-scale policy revisions in the near future would appear to be low.

In terms of whether or not high inflation will be sustained and the Bank of Japan will judge the achievement of its 2% price target to be in sight, what the bank is focusing on most of all right now is clearly next year’s spring wage negotiations. Given this, there is probably a rather low chance that it will choose to raise interest rates at the preceding MPM in January. A full-scale policy change will presumably have to wait at least until the April MPM, immediately following the negotiations. 

Very low chance that the BOJ will proceed with policy revisions with confidence about achieving its price target (first scenario)

I would posit that there are three possible scenarios for the process that would lead the bank to embark on full-scale policy revisions, such as eliminating its negative interest rate policy. This would be predicated on Governor Ueda and the Bank of Japan Secretariat deeming the side effects from the current extraordinary monetary easing program to be too great, and being strongly inclined to find some pretext for revising it.

Under the first scenario, in response to significant wage growth from next spring’s wage negotiations (base pay increase of 3% to 4%), the Bank of Japan would honestly judge the achievement of its 2% price target to be in sight, and would declare just that. Subsequently, it would proceed apace with policy revisions.

However, the chances of that happening are likely very low. Former Governor Kuroda stated that macro wage growth in line with achieving the 2% price target would be a base pay increase of 3%. Base wage growth from this year’s negotiations was just over 2%, but the recent growth rate in regular wages has been around plus 1.5%, and the average growth rate in base pay including SMEs and micro-enterprises is around this level.

The possibility that this would accelerate to growth of over 3% in next spring’s negotiations is likely limited. The latest inflation rate, which serves as a reference during those negotiations (Core CPI), was 4.2% this past January, whereas it’s expected to briefly hit plus 2% in January of next year. With the inflation rate set to be no more than half of what it was this year, there is probably little chance that base pay will grow much faster. The unexpectedly high wage growth rate this year also owes much to the upswing in inflation having been passed on to wages.

Moreover, back in the early 1990s when the 2% price target was achieved, the labor productivity growth rate, which determines the growth rate in real wages was more than plus 3.5%. Based on that, the trend for the growth rate in base pay is considered to have been around plus 4%. There is an extremely small chance that base pay growth will further accelerate to that extent in next spring’s negotiations.

In fact, we should even consider the possibility that base pay growth will fall to the range of plus 1%. For that reason, it’s unlikely that in response to next spring’s wage negotiations, the Bank of Japan will declare confidence about achieving its 2% price target and then declare as much.

High risk that the BOJ will declare the price target achieved—despite not actually believing it achievable—and proceed with policy revisions (second scenario)

However, if the Bank of Japan is inclined to find a pretext for making some sort of revision to its current monetary easing policy, then it’s likely possible that even if it doesn’t really believe it can achieve its 2% price target, it will nevertheless declare that achievement to be in sight and then move to undertake policy revisions. The possibility of this second scenario is clearly higher than that of the first.

The Bank of Japan’s Core CPI forecast is growth of 2.6% in FY2023, meaning the forecast has significantly surpassed 2% for a second consecutive year. If the wage growth from next spring’s wage negotiations leads the wage growth rate to remain relatively high despite falling below this year’s level, and the FY2024 price outlook (currently plus 1.9%) gets revised upward to over 2% growth, then for a third straight year the inflation rate would significantly exceed 2%. In this scenario, the Bank of Japan would use this development as its pretext to declare that the achievement of its 2% price target is finally in sight, and would move to eliminate its negative interest rate policy at next April’s MPM at the earliest. 

Yet if the bank were to declare its 2% price target to be achievable, speculation would intensify in the financial markets that short-term interest rates will be raised to the level of 2% or higher, and consequently, the chance would emerge for 10-year JGB yields to jump up to around 3%. This would throw the financial markets into major turmoil.

If the 2% price target were actually achieved, and inflation expectations were also to stabilize at the level of around plus 2%, then this kind of rise in long-term yields likely would not deal a significant blow to the real economy. But in actuality, with the 2% price target not set to be achieved, and inflation expectations apt to stabilize at rather a lower level than plus 2%, if long-term yields were to rise this far with policy revisions accounted for, the real economy would probably be dealt a very great blow indeed.

That would lead the inflation rate to fall sharply from plus 2%, exposing the Bank of Japan to sharp criticism that its full-scale policy revision was premature and a failure.

Elimination of the negative interest rate policy possibly to come late next year or thereafter (third scenario)

In light of these points, the most highly probable scenario would be a third one. In this scenario, the wage growth rate in next spring’s negotiations would fail to reach the expected level, and in response the Bank of Japan would declare that its 2% price target cannot be achieved in the short term. In that case, the Outlook Report next April would likely indicate projections for inflation to fall well below 2% not only in FY2025 but in FY2026 as well.

Moreover, the bank would announce a prolongation of its monetary easing, and would choose a new policy that involves revisions to the monetary easing framework in preparation for a long and drawn-out struggle. The bank would probably explain this by stating that prolonging easing as-is would also exacerbate its side effects, which in turn would impede the continuity of easing and preclude the price target from being achieved. Based on that explanation, the bank would ostensibly be aiming to mitigate any side effects, while actually embarking on a full-scale policy revision albeit at a moderate pace. In this case, we likely would not see any sharp rise in yields, as with the second scenario. The Bank of Japan would be able to move ahead progressively and gradually with revising its policy, following the pace it envisions.

And unlike the YCC tweak in July, a move that had been predicted to come as a surprise, we can expect that these policy revisions will be implemented to allow the financial markets plenty of time to factor them in. For this reason, it’s unlikely that the bank will move to eliminate negative interest rates next April immediately after seeing the results of the spring wage negotiations. It’s more likely that late next year is the earliest we’ll see the BOJ actually eliminate its negative interest rate policy, after it’s made a multifaceted review and fully explained the side effects of that policy to the financial markets.

Furthermore, it’s also conceivable that a deterioration in domestic and international economic conditions or monetary easing in the U.S. could cause the Bank of Japan’s policy revisions to be delayed. Depending on those developments, it’s probably even possible that the timing for eliminating the negative interest rate policy could be pushed as far back as 2025.

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  Takahide Kiuchi

  Executive Economist