The end of an era? Experts react to the Bank of Japan’s interest rate hike

After seventeen years, last Tuesday the Bank of Japan made the decision to raise short-term reference interest rates to 0.1%, reversing a monetary policy that for a long time remained predominantly negative with the aim of stimulating a stagnant economy. This move was motivated by overcoming deflation in the country and the prospect of a "moderate" economic recovery.

The Bank of Japan was the last among the world's central banks to maintain negative rates, thus marking the end of an era in which governments around the world sought to promote growth through easy money policies and unconventional monetary measures. But what do experts think about it? Let's find out:

Gurpreet Garewall, Macro Strategist, Fixed Income and Liquidity Solutions, Goldman Sachs Asset Management

The rate hike, the first since 2007 and the end of yield curve control, marks the end of an unconventional policy regime.

Strong wage growth, coupled with core inflation above 2% since the end of 2022, have helped the Bank of Japan gain confidence in the virtuous circle between wages and inflation. The measured reaction from the markets could be explained by the likely belief that the BoJ will adopt a "one-off" approach.

We foresee further rate hikes, albeit limited, considering that real rates in Japan remain low and financial conditions are not tight compared to the inflation scenario.

Ben Powell, Chief APAC Investment Strategist, BlackRock Investment Institute

The historic step of the Bank of Japan (BoJ) to raise rates for the first time since 2007 marks the end of an extraordinary era of unconventional monetary policy aimed at pulling the Japanese economy out of decades of deflation or low inflation and stagnation. The BoJ has raised the reference rate from -0.1% to a range between 0.0-0.1%, has removed the cap on yields of ten-year government bonds and has declared that it will stop buying exchange-traded equity funds and real estate investment funds.

In our view, the BoJ's policy change is part of a careful and considered strategy of normalizing monetary policy and is not due to a policy of monetary tightening. So far, the central bank has managed the normalization process - including the steady easing of yield curve control over the past 15 months - without destabilizing the markets. Today's decision was made following strong wage growth. The largest union federation, Rengo, reported last Friday that workers at the country's largest companies will receive the largest wage increase in over three decades. The BoJ's confidence in a return to sustained inflation, supported by a recovery in wage growth, has laid the groundwork for ending negative interest rates after eight years. But after this laborious return to inflation, we believe it is unlikely that the BoJ will sabotage these advances with an aggressive tightening of monetary policy, as Governor Ueda reiterated during the press conference.

The result? In our opinion, the macroeconomic context of Japan remains favorable to risk. The BlackRock Investment Institute overweight Japanese stocks, even after their recent gains, and underweight Japanese government bonds. We believe that the outlook for the stock market is supported by a positive earnings momentum, from the acceleration of shareholder-friendly reforms underway throughout Japan Inc. and from the support to negative real interest rates. In our opinion, the sun is not setting on Japanese stocks, but is simply rising on a new horizon.

Kensuke Niihara, Chief Investment Officer for Japan, State Street Global Advisors

The changes were expected and largely already priced in, even though the Bank of Japan has anticipated our expectations by paying a positive rate of 0.1% to all current account balances (excluding mandatory reserves). We believe this is a reasonable move in the current economic context, particularly with regard to inflation and wages.

Considering that the accommodating policy will be maintained for a while, we do not expect this to change the dynamics of the stock and currency markets. We believe that this change does not affect the bullish hypothesis of Japanese stocks. However, with less clarity of the forward guidance, particularly regarding the pace of rate hikes and forward rates, as well as the end of yield curve control (YCC), we are monitoring the developments of the long part of the curve, that is beyond 10 years, and the change in demand for foreign bond investments.”

Christoph Siepmann, Senior Economist, Generali Investments

A month earlier than expected, the BoJ today removed its NIRP and YCC in one fell swoop, along with the cessation of ETF, J-Reits purchases and the announcement to reduce the purchase of CP and corporate bonds (to be stopped in about a year). However, the bank will continue with the core of its relentless policy, namely the purchases of government bonds with approximately the same amount as before (around JPY 6 tr per month), while it has guaranteed its own freedom of action, in the event of a rapid increase in long-term interest rates. It will also continue its "loan financing" program. So far, we interpret the BoJ's decision in line with our forecasts, which we discussed more thoroughly in a recent Core Matter.

The BoJ has become more convinced that the much-desired wage-price virtuous cycle is actually stabilizing. Its statement reads that "[…] the Bank has judged that it has come to light that the price stability target would have been achieved sustainably and stably towards the end of the projection period." The BoJ mentioned the positive influence of recent wage agreements of large companies, which reached 5.28%, a 33-year high. However, medium and small-sized companies will follow, and it is not expected that they will accept such high increases. However, we also expect an increase in disposable income this year thanks to the three elements of wage increases, government fiscal support, and slowing inflation. This in turn should support private consumption, the second necessary part for sustainably higher inflation.

Having said that, we expect the BoJ to remain cautious in raising its key interest rate. The bank still needs to fuel the wage-price cycle, exactly the opposite of other major central banks that fear that high wage growth complicates the return of inflation below target. We expect the BoJ to remain accommodating, expanding its monetary base in line with the expected nominal GDP growth (2% inflation target plus potential growth) of 2.5% - 3% in the coming years.

In the press conference, Ueda said "we will choose the appropriate level of short-term rates in line with our economic and price outlooks. But in doing so, we must bear in mind that there is a certain distance for inflation expectations to reach 2%. When we focus on this gap, it is necessary to maintain accommodating monetary conditions even in a context of normal monetary policy." As a result, we do not see a rise in short-term rates, especially not this year. The models suggest that even with annual wage growth between 3% and 3.5% in the coming years, Japan's inflation would not advance beyond 1.8% in the forecast horizon. Only if wage growth dynamics substantially accelerated, driving inflation above 2% on a sustained basis, would we see the BoJ raise its interest rate. But this is not our forecast. Inflation peaked at 4.1% in January 2023, and is on the decline, although it will be noisy in the coming months. We expect headline inflation to rise again in February to 2.8% (after 2.2% in January) due to the end of base effects. However, overall, we expect inflation at 1.9% this year and 1.6% in 2025. The latter is in line with consensus forecasts. If this were to happen, it would not allow the BoJ to sustain an overshoot of inflation.