The Bank of Japan in its two-day meeting on the 16th and 17th of June, elected to keep policy rates unchanged. Short-term interest rates would stay negative at -0.1%, while long-term rates would be held near 0%.
The BoJ and Governor Kuroda Haruhiko, who is now in the final year of his term, has stressed that easy monetary conditions will continue, in a bid to improve anemic growth.
This policy stance is in direct contrast to the tightening engaged by other global central banks.
Market players had speculated that the BoJ may abandon its ultra-low rate policy as central banks around the world have entered a new hiking cycle, while in a shock move this week, the Swiss National Bank, a safe-haven currency and export-dependent economy like Japan, raised rates for the first time in 15 years.
At the time of writing, the yen is 16.5% lower against the dollar on a year-to-date basis, and 21.6% lower over the last twelve months.
Inflation and the way of the yen
Inflation is expected to see an uptick based on pressures from rising telecom costs, a weakening yen resulting in higher import prices, and other external factors.
Source: US FRED
The monthly inflation rate has surged to 2.4% in April from 1.2% in March, even though it was negative as recently as August.
High commodity prices and supply disruptions due to both the pandemic and the Ukraine-Russia war have raised prices in the traditionally inflation-averse society. Shortages in oil supplies and agricultural production have seen critical costs rise.
However, with the country having been in a deflationary environment for decades, it is still muted compared to other countries.
In fact, the BoJ wants inflation to rise and for core inflation to reach above 2%, after experiencing a prolonged deflationary period.
However, rising inflation does not imply that the economy is healthy because prices are not led by faster-paced domestic business activity but by higher international costs.
Capital outflows and a weakening yen
The actions of other central banks follow record-high inflation in several advanced countries on the back of labor shortages, elevated commodity prices, and broken supply chains due to the Ukraine-Russia war.
Until recently, the Yen was seen as a safe-haven currency. It was a destination for markets to park funds during high volatility and macro uncertainty.
This has changed drastically in recent times, with other central banks, primarily the Federal Reserve raising interest rates to stem higher prices.
The dollar is still the king of fiat currencies. Its globally respected institutions (in comparison to those of other nations), an unmatched depth of bond markets, and abundant liquidity have led investors to seek refuge in the dollar. The rise in key rates has improved returns, and other currency holdings have gravitated towards the US. These are known as capital outflows (from Japan and other countries).
Amid capital outflows, demand for the yen has reduced, leading to weakness in the yen as compared to the dollar.
As a result, import prices (marked in dollars) have risen in yen terms, accelerating costs and inflation at home.
In all likelihood, the yen will continue to weaken, if the BoJ pursues its ultra-loose policy and the Fed tightens between 50 – 75 bps during the next meeting. In a sense, the authorities are banking on a rise in growth rates before yen depreciation gets out off hand.
Japanese growth faced a sharp downturn during the pandemic.
Economic activity has stalled during the pandemic, and with a median age of approximately 49 years, overall productivity remains low while the dependency ratio continues to rise.
The inexpensive yen may support exports to power growth, but the upside will likely be limited as global growth slows.
On the flipside, easy money ensures that zombie companies remain operational and other inefficient business practices are not weeded out, ultimately harming growth prospects.
Crucially, monetary policy interventions are supposed to provide a short-term boost to the economy and are not suited to long-term policy.
However, the BoJ feels raising rates would be catastrophic and dampen an already challenging economic picture.
According to Momma Kazuo and Yamamoto Kenzo, both formerly executive directors at the BoJ, the real antidote for Japan’s growth woes may lie in structural reforms. These tend to be long, arduous journeys of decisive and dedicated collective action, compared to the ‘easy’ fix of keeping rates low.
Speculators take on the BoJ
The market is rife with reports that the BoJ purchased bonds worth $5.2 billion on Wednesday alone, to keep the yield on 10-year government securities capped at 0.25%.
Speculators believe that with prolonged ultra-loose monetary policy and rising import costs, inflation must head higher and will take bond yields with it, making government borrowing more challenging.
The BoJ has committed to defending its ceiling, for now, but is likely to see markets attack its positions more aggressively.
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