The Bank of Japan’s Year of Living Dangerously

Global investors are convinced 2024 will be the year the Bank of Japan (BOJ) finally “normalizes” policy and hikes interest rates above zero. Making the wrong bet could cost the nation dearly.

Negative interest rates have been a hallmark of Japanese monetary policy since 2016, with the BOJ maintaining ultra-easy policy to conquer deflation. Yet with inflation having exceeded the central bank’s 2 percent target for over a year, and amid signs of higher wages growth, economists are increasingly confident of an end to negative rates this year.

In its latest policy meeting on January 23, the central bank maintained its ultra-easy settings, pointing to “extremely high uncertainties.” Nevertheless, BOJ Governor Ueda Kazuo hinted that conditions for a policy change were gradually falling into place.

“Prospects of higher wages are gradually affecting sales prices, which is leading to a gradual increase in service prices,” Ueda told a press conference after the BOJ's policy announcement.

“If we get further evidence that a positive wage-inflation cycle will heighten, we will examine the feasibility of continuing with the various steps we are taking under our massive stimulus program,” he said.

Ueda indicated the full range of the BOJ’s policy armory, including negative rates, yield curve control, government bonds, and equity buying, would be on the table when it begins normalizing policy.

Ueda’s remarks helped spark a rebound in the Japanese yen and stock market, with the short-term government bond yield hitting a one-month high the same day.

In its latest quarterly outlook, the central bank projected inflation would remain above 2 percent through fiscal year 2024 due to higher import prices and other factors, with consumer prices only easing back below its target the following year. 

However, the report suggested a “virtuous cycle” from income to spending was intensifying, with the likelihood of achieving its price stability target continuing to “gradually rise.”

"The BOJ is signaling that the pieces are falling into place for ending the negative interest rate," Shunsuke Kobayashi, chief economist at Mizuho Securities told the Nikkei.

April Move?

Ueda gave little indication of an early exit at the January 23 press conference, only saying “it is difficult to say how close we are [to the exit] in a quantifiable way.”

While the BOJ’s next monetary policy meeting is scheduled for March 18-19, economists suggest the following meeting on April 25-26 could prove more noteworthy.

“Ueda's comments heightened my conviction the BOJ will end negative rates in April,” Mari Iwashita, chief market economist at Daiwa Securities, told Reuters.

“He suggested that the BOJ doesn’t need to wait too long in scrutinizing this year’s wage outlook. Furthermore, he no longer talks about the danger of a premature exit,” she said.

Capital Economics suggests the central bank will wait for the results of February’s nationwide consumer price index (CPI), which will be released after the BOJ’s March policy meeting.

Japan’s core CPI increased by 3.1 percent in 2023, its biggest gain since 1982, on higher food costs and greater import prices due to a weaker yen.

However, there are signs of slowing inflation, with the Tokyo CPI diving from 2.4 percent to 1.6 percent in January, putting it below the BOJ’s target for the first time in two years.

“The upshot is that the [BOJ] will now want to see the results of the February nationwide CPI, which will only be released after the Bank’s March meeting, to ensure that price pressures haven’t subsidized altogether,” Capital Economics said in a January 26 report.

“If those figures show a renewed acceleration in price pressures, we think the bank will press ahead with ending negative rates in April. What’s increasingly clear though is that the bank won’t need to embark on a full-fledged tightening cycle.”

Tokyo-based economist Jesper Koll agrees, telling The Diplomat that 2024 will be the year of the “reliquefication of money markets.”

“Last year, around 90 to 95 percent of the liquidity in the Japanese government bond market was from the BOJ… now it’s down to around 15 to 20 percent, so Governor Ueda has been successful in reliquefying the government bond market,” said Koll, who is the expert director at Monex Group.

“This year will be about the reliquefication of the money markets. I expect that by April or May, the BOJ will increase its policy rate to around 10 to 15 basis points – normalizing policy, not tightening.”

Koll said the BOJ’s scope for a policy change would be supported by planned income tax cuts by the administration of Japanese Prime Minister Kishida Fumio in 2024. 

In December, Japan’s ruling coalition approved cuts in income and resident taxes, together with incentives for businesses to hike wages, aimed at achieving a “virtuous cycle in the economy.”

“That fiscal policy easing will give greater freedom for the Bank of Japan to start the normalization process,” Koll said.

Economic and Political Worries

Kishida is gambling that private consumption revives on the back of real wage hikes at the spring “shunto” labor-management negotiations. Last year’s shunto talks resulted in an average wage rise of around 3.6 percent, a 30-year high, and the Japanese Trade Union Confederation is pushing for at least a 5 percent increase this year to counter inflation.

Kishida has described the talks as “a critical moment in determining whether Japan’s economy will revert back to deflation or move toward a complete escape from deflation.”

Positive momentum on wages could help counter a fundraising scandal in Kishida’s ruling Liberal Democratic Party (LDP) that has seen his Cabinet’s approval rating fall to record lows.

A Nikkei poll published January 29 showed Kishida’s Cabinet still near the record low approval rating recorded in December 2023, with just 27 percent support. 

With the LDP set to hold a presidential poll in September 2024 – effectively deciding the nation’s prime minister – Kishida lags party rivals in the public approval stakes. 

The Nikkei poll found support for former LDP Secretary-General Ishiba Shigeru at 22 percent, followed by former Environment Minister Koizumi Shinjiro at 15 percent and Digital Transformation Minister Kono Taro at 10 percent. Kishida came seventh, with just 3 percent support.

Yet the latest gross domestic product (GDP) data released February 15 made grim reading for proponents of a BOJ policy change.

Japan’s GDP contracted at an annualized rate of 0.4 percent in the December quarter, which following the previous quarter’s revised 3.3 percent decrease meant it technically fell into recession.

Both private consumption and capital expenditure declined in the December quarter, although exports rose. 

The data surprised economists, with only one of 34 surveyed by Bloomberg tipping a contraction.

The Cabinet Office report also showed Japan losing its third-placed global economic ranking to European powerhouse Germany. Japan’s nominal GDP stood at $4.21 trillion in 2023, below Germany’s $4.46 trillion, with a weak yen contributing to the decline.

The markets reacted to the GDP data by pricing in a 63 percent chance of the BOJ raising rates by April, down from 73 percent a day earlier.

“Weak domestic demand makes it hard for the BOJ to pivot toward monetary tightening,” Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities, told Reuters. “The hurdle for ending negative rates in March has risen.”

However, Capital Economics’ Marcel Thieliant said the GDP contraction would not prevent the BOJ ending negative rates.

“While job vacancies have weakened, the unemployment rate dropped to an 11-month low of 2.4 percent in December. What’s more, the Bank of Japan’s Tankan survey showed that business conditions across all industries and firm sizes were the strongest they’ve been since 2018 in [quarter four],” he said in a February 14 report. 

“The [BOJ] has been arguing that private consumption has ‘continued to increase moderately’ and we suspect that it will continue to strike an optimistic tone at its upcoming meeting in March. An upward revision is still possible in the second estimate of [fourth quarter] GDP, due on March 11, and we doubt that today’s GDP figures will prevent the bank from ending negative interest rates in April.”

The Japanese government projects GDP growth of 1.6 percent for fiscal year 2024, easing to 1.3 percent in the next fiscal year starting in April, with planned tax cuts and wage hikes expected to support domestic demand even amid a weak global economy.

However, in its latest “World Economic Outlook” report the International Monetary Fund (IMF) sees Japan’s GDP growth slowing from 1.9 percent in 2023 to 0.9 percent in 2024 and 0.8 in 2025, “reflecting the fading of one-off factors that supported activity in 2023.”

Similarly, the Organization for Economic Cooperation and Development (OECD) sees Japan maintaining a 1 percent GDP growth rate in both 2024 and 2025, with headline inflation contracting to 2.6 percent this year and 2 percent in 2025.

In a January 11 report, the Paris-based organization said Japan needed to “focus on ensuring fiscal sustainability, boosting productivity growth, and addressing the economic and social impacts of rapid population aging.”

Despite Japan’s mixed GDP data, the Japanese stockmarket has continued to hit new highs. On February 16, the benchmark Nikkei Stock Average closed at 38,487, reaching a new 34-year high and within touching distance of its all-time high of 38,957 achieved during the “bubble economy” era on December 29, 1989.

Nikko Asset Management sees the gains continuing in 2024, aided by corporate governance reforms, increased merger and acquisition (M&A) activity, and “buoyant” consumption driven by higher wages. With Tokyo targeting raising the national minimum wage by 50 percent by the mid-2030s, wage hikes will be “front and center in Japan’s economic agenda,” it said in a December 2023 report.

“In 2024, the government will be waiting for the right moment to officially announce victory over deflation, although the exact timing of this will largely be a function of political dynamics. Even so, it appears Japan’s policymakers and politicians are aligned, and the exit from deflation and the normalization of monetary policy should therefore be well orchestrated,” it said.

Koll of Monex said increased business investment and wages growth will push Japan’s GDP higher, rising at around 2 to 2.5 percent in 2024, with the Nikkei to top 44,000 on the back of improved corporate earnings.

He argued there was a new “corporate metabolism” in Japan with the average age of a Nikkei 225 CEO dropping by almost 10 years and a record amount of domestic M&A.

“During the last 20 years the vast majority of Japanese companies were playing defense. Now the new generation of CEOs is actually playing offense,” he said.

“They are buying companies, they are building new factories, and this is where the primary source of optimism comes from.”

Another positive factor for Japan was its increased level of foreign workers as well as tourists.

In 2023, the number of foreign workers in Japan hit a record 2.04 million, up 12 percent from 2022. Japan also welcomed 25 million overseas visitors last year, reaching 79 percent of the pre-pandemic level in 2019, with foreign tourists spending an estimated $35.7 billion, the highest amount on record. 

These trends are expected to continue in 2024, although a broader-based retail revival will depend on the wallets of Japanese consumers, who have been hit hard by rising inflation.

“We will do everything possible to achieve income hikes that exceed price rises this year. We must make this a reality,” Kishida told the Diet on January 30.

Will the BOJ end negative rates soon, as market watchers anticipate? Much will depend on the March shunto results, together with the February CPI figure and April’s quarterly “Tankan” survey of business sentiment.

“It’s just a question of timing,” a government source told the Nikkei.

Circumstances may never be better for a BOJ policy shift than in 2024, Asia’s Year of the Dragon. Ueda will need all the famed courage and intelligence of the mythical creatures if he is to survive this baptism of fire.