Bank of Japan to keep negative interest rates

Navigating inflation nuances and economic signals for Q4 in Japan

By Ahmed Azzam | @3zzamous | 28 October 2023

Bank of Japan to keep negative interest rates
  • Bank of Japan maintains a careful monetary stance.

  • Strong but temporary inflation prompts BoJ attention.

  • Governor eyes YCC shift with inflation aligning wage growth.

The Bank of Japan (BoJ) has recently reiterated its cautious stance on monetary policy in its latest meeting, maintaining continuity in its language and keeping its forward guidance unchanged.

Despite the emergence of firmer-than-expected inflationary pressures, the BoJ remains steadfast in its policy stance. In its official statement, the central bank anticipates a deceleration in inflation and attributes the recent uptick in core inflation, hovering at approximately +3%, to pass-through effects stemming from rising prices.

During the subsequent press conference, BoJ Governor Kazuo Ueda stated: ‘If inflation, coupled with progress toward our wage growth target, becomes apparent, the BoJ will contemplate discontinuing its Yield Curve Control (YCC) policy and consider a shift in interest rates.’

This statement reflects the BoJ's belief that the current spike in inflation is predominantly driven by temporary cost-push factors rather than sustained structural changes.

Complex inflation picture: Resilience and pressures

Recent inflation data, however, presents a more complex picture, with inflation exhibiting greater resilience and stickiness than initially anticipated.

There are discernible indications of mounting pressures on both the demand and supply sides of the economy. Headline consumer price data for August registered a year-on-year increase of 3.2%, a slight moderation from July's 3.3%, albeit remaining slightly above the market consensus of 3.0%. Core inflation, which excludes the volatile components of fresh food and energy, held steady at 4.3% for the second consecutive month.

The surge in prices for private services, such as entertainment, over the past few months has been noticeable, boosted by the resurgence of foreign tourism, which has added upward pressure. Furthermore, producer and import prices have risen significantly due to elevated commodity costs.

The unemployment rate has maintained a relatively stable average of 2.6%, although there’s a possibility for some uptick in the fourth quarter. Despite the fluctuating economic growth trajectory, the latest data for the second quarter still reveals a growth rate of 1.2%, albeit with several negative readings since 2021. This oscillating growth pattern is a source of concern for the BoJ, as it underscores the potential risks associated with aggressive policy changes that could precipitate economic contraction.

BoJ's future moves: October adjustments

Looking ahead, it’s reasonable to anticipate that the BoJ will consider making another policy adjustment in October, possibly culminating in its first attempt at raising interest rates in the second quarter of the coming year.

Consumer prices are likely to remain above the BoJ's projections, and clearer indications of demand-driven inflationary pressures are expected to emerge over the next few months. These developments could enable the BoJ to proceed directly to the removal of the YCC framework, rather than engaging in further adjustments, such as expanding the 10-year yield cap or altering the target yield to a shorter maturity.

Regarding the timing of a rate hike, the BoJ is expected to exercise caution and await sustained evidence of robust wage growth, suggesting that any such move is more likely to materialise in the subsequent year. It’s worth noting that the BoJ's historical pattern has been to initiate interest rate hikes in coordination with the conclusion of the US Federal Reserve's tightening cycle.