At its latest monetary policy meeting, the Bank of Japan voted to end its negative interest rate policy (NIRP), abolish yield curve control (YCC), and phase out purchases of risk assets. This marks the end of a period utilising “large-scale monetary easing measures”, as the Bank’s inflation target of 2% is expected to be achieved. However, the Bank effectively increased rates by only 10bps, now focusing on a short-term rate target of 0-0.1%, from the previous level of -0.1%. As a result, monetary policy in Japan remains much looser than the rest of the developed world. 

Shift in policy 

The shift in policy was well telegraphed to markets, with a series of leaks to the media over the past few weeks suggesting a change was imminent. This helped to avoid market dysfunction. Governor Kazuo Ueda reiterated a dovish tone at the press conference following the meeting, indicating that the Bank’s stance will remain accommodative for some time. However, he left options open for future changes in policy, such as further rate hikes or balance sheet reduction. 

While we had expected the Bank of Japan to remove NIRP this year, this change came earlier than we had pencilled in. Policymakers are trying to erase the deflationary mindset that the Japanese economy has seen over the past thirty years and signs of progress are materialising across multiple fronts, with a “virtuous cycle between wages and prices” beginning to form. The main evidence for this was the initial outcome of the annual Shunto wage agreement process, indicating settlements at 5.3%. While the final number will likely be lower, this was a major increase on the number seen at this time last year, and the highest reading for over 30 years. Separately, the equity market has been a source of attention for global investors as a weak Japanese Yen (JPY) and corporate reforms help to attract investment flows, driving strong performance.  

Despite this, domestic activity remains weak. Q4 2023 GDP showed that domestic demand was negative for a third consecutive quarter, indicating that Japanese consumers remain cautious following the increase in inflation.

Looking ahead 

For the Bank to be confident that a virtuous cycle has taken hold, we think that positive momentum will have to transition from external demand (driven by weak JPY, equity flows, imported inflation) to domestic demand (stronger wages, consumption, domestically driven inflation). This pivot is indeed underway, with the substantial increase in wages looking broad-based and fiscal policy also seeking to encourage higher consumption. The Bank is in a relatively comfortable position, where inflation is falling towards target, growth is expected to reaccelerate, and wages are rising. This means they are not being forced to tighten policy and can maintain an accommodative stance while removing the extreme easing measures that marked the Kuroda regime.