The Bank of Japan took an historic step in its March meeting, ending the era of negative interest rates. But the tone of the central bank was cautious overall - with good reason.
What happened
At long last, the Bank of Japan (BOJ) has decided to end its policy of negative interest rates and yield curve control, moving the lower bound of the interest rate range up from -0.1 per cent to zero. The bank will stop buying exchange-traded funds and Japanese real estate investment trusts - two pillars of its qualitative and quantitative easing programme - and, within a year, corporate bonds and commercial paper. Only Japanese government bond (JGB) purchases will carry on.
What tipped the balance in the end was the increasingly robust relationship between wages and prices, following some solid pay rises from the recent Shunto wage negotiation. After decades of negligible price growth, the central bank has become more convinced that its two per cent inflation target will be achieved in a sustainable and stable manner by 2026.
In future, the bank will use the short-term interest rate as its primary policy tool for maintaining price stability. Despite the changes, the BOJ will continue to maintain an accommodative stance.
Our interpretation
Investors have been expecting this change for some time. The BOJ was, after all, the last central bank left running negative rates. The decision was carried through with only two votes against on the monetary policy committee, but there was no sense of euphoria in Governor Kazuo Ueda’s tone on Tuesday. At a press conference, he refused to directly address when and how the BOJ will approach future rate hike decisions, while reiterating the need to keep financial conditions accommodative.
This is a sensible stance. At home and abroad, the BOJ faces risks in its mission to stabilise prices. Recent data suggests that underlying growth momentum in private consumption is not yet solid. A slowdown in the US and Europe continues to weigh on the minds of policymakers. That’s why the bank has afforded itself some wiggle room, for example, by maintaining the pace of JGB purchases through to June, as it awaits more evidence of sustainable inflation.
Outlook
A lot will depend on where inflation goes from here. We believe that a virtuous wage-price cycle is likely to be sustainable, ultimately leading to a higher neutral rate for Japan. The BOJ may need to hike its policy rate further to adhere to the 2 per cent price stability target if the wage-price cycle gains momentum.
Maintaining an appropriate pace of rate hikes will also be important to the yen as the yield gap with the US remains wide, especially with the US Federal Reserve poised to stay higher for longer. In the interim, we think the Ministry of
Finance is likely to intervene verbally if USDJPY remains persistently above 150.
More clues will soon trickle through. The market’s attention will now turn to the April Tankan survey on business sentiment and capital investment plans; the BOJ’s branch managers' meeting happening in the same month, which will provide updates on wage increases at small and medium-size enterprises; and above all, any revisions in the central bank’s own inflation forecasts in its next formal outlook in April.
Asset Allocation views
The bank’s decision does reinforce our upbeat view on Japanese equities. Recent economic surprises and earnings revisions have been positive, while business activities continue to recover in Japan. But we maintain a neutral view on the yen because we see the BOJ sticking to a gradualist approach, while the Fed’s rate cuts are pushed further out.
