The writer is chief Japan economist at JPMorgan in Tokyo
When will the Bank of Japan shift its monetary stance to reflect the reality of increasingly sticky inflation? Predicting policy remains difficult but the central bank’s interpretation of economic change remains as significant as the data itself.
Recent wage and inflation data already justify some scaling back of the current super-accommodative monetary stance. The BoJ will probably revise its inflation forecasts upwards in its outlook report due on July 28, indicating that it expects inflation will remain higher than initially thought.
As a result, we expect policymakers to widen the yield cap on 10-year Japanese government bonds to plus or minus 1 per cent at its policy meeting on the same day. It has stood at plus or minus 0.5 per cent since December 2022.
The BoJ’s recent communications suggest that the July meeting will be include active policy decisions. Deputy governor Shinichi Uchida told Reuters earlier this month that the BoJ would make a balanced decision on tweaking its yield curve control policy, under which the bank intervenes to keep JGB yields within a certain range.
Governor Kazuo Ueda has indicated the BoJ will scrutinise at each policy meeting the pace of progress Japan is making in sustainably achieving its 2 per cent inflation target.
Japan’s inflation dynamics are clearly changing. Upward pressure on prices and a combination of structural and cyclical factors has heightened pressure on wages, leading to a rise in inflation expectations.
With underlying prices continuing to rise a year after the global price shocks caused by Russia’s invasion of Ukraine, the BoJ’s argument that the rise in inflation is temporary is becoming untenable; even the government now expects inflation to average 2.6 per cent during fiscal 2023 against the BoJ forecast of 1.8 per cent.
So far, the BoJ has justified continuing its easy monetary policy stance by reference to a subdued inflation outlook. Rate-setters are likely to continue to argue they are not yet confident of achieving the 2 per cent inflation target in a sustainable manner.
But expectations are rising that the BoJ will revise up its full-year 2023 inflation forecasts and acknowledge that they are getting closer to the point where confidence in inflation remaining above 2 per cent for two consecutive years would be justified.
In such an environment, there would no longer be a case for maintaining the super-accommodative monetary policy, which was introduced at a time when inflation had remained well below 1 per cent for an extended period. In addition, the chances of a global recession, flagged as a big risk to Japan’s economy, have receded recently.
While upward revisions to the BoJ’s inflation outlook appear almost inevitable, the possibility of no policy changes cannot be excluded. But that would leave the bank facing not only communication problems but an increased risk of abrupt policy changes in the future.
A change in monetary policy consistent with an expectation that the stable inflation target of 2 per cent will be achieved would, to our minds, include raising policy rates to the neutral level, not just removing the yield curve control regime and — by the middle of next year — the negative interest-rate policy.
Recent market fluctuations also justify some policy revisions. The yen has risen and currency market volatility has increased. The longer the BoJ delays policy adjustments, the greater this volatility is likely to become.
Last year, the BoJ’s dovishness contributed to a rapid weakening of the yen that required intervention in the foreign exchange markets. If the bank wants to avoid a similar experience this year, it would be reasonable to start gradually scaling back policy as inflation prospects change. Also, it would not be desirable for the central bank to continue holding so much of the outstanding 10-year government debt if the economic fundamentals that informed such a policy no longer apply.
Monetary policy has become highly complex over the past 10 years. The BoJ may need to abolish YCC and start shrinking its bloated balance sheet before it begins to raise policy rates. Plus, years of prolonged monetary easing have left Japan’s economic structure and government financing vulnerable to higher interest rates, and the BoJ may be required to pay close attention to the potential negative impact on both, requiring it to take a gradual approach.
So even if YCC is adjusted, expect the BoJ to continue to send dovish signals to the market and keep monetary policy extremely accommodative for some time. The result would be that Japan’s real policy rate will be left at its lowest level ever in the coming years.
Source: Economy - ft.com
