The Bank of Japan has ended the most aggressive monetary stimulus program in modern history, removing the last negative interest rate in the world and a series of unconventional tools. However, the timing of further hikes remains uncertain.
BOJ Governor Ueda is the first former academic to head the BOJ. He had already adjusted some aspects of the ultra-loose policy settings he inherited when he became governor. Few analysts predicted that Ueda would be able to end the negative interest rate policy instituted by his predecessor in less than a year. His predecessor, Haruhiko Kuroda, launched a series of shock measures in April 2013 to achieve a 2% inflation target within two years. With this target remaining out of reach, Kuroda adopted a negative interest rate policy in 2016, followed by yield curve control (YCC) measures, which allowed the yield on 10-year Japanese government bonds to fluctuate by 50 basis points in either direction from the 0% target.
Extended monetary easing had led to the BOJ’s balance sheet expanding to 127% of the annual economy, four times more than the Federal Reserve’s assets-to-economy ratio. Despite this, inflation had never taken off. Japan’s main inflation gauge has remained at or above the 2% target for 22 months, which is expected to continue.
The central bank has set a new target range for the overnight rate between 0% and 0.1%, shifting from a short-term interest rate of -0.1% after stating that its 2% inflation target was within reach. BOJ also abandoned its complex yield curve control program while committing to continue buying long-term government bonds if necessary. It also ended its purchases of exchange-traded funds (ETFs). The central bank had adopted the highly unusual measure of buying risk assets like ETFs in 2010, becoming the largest holder of Japanese stocks. The optics of using this measure have become increasingly delicate as Japanese stocks reached record highs this month.
The bank’s indication that financial conditions will remain accommodative showed that its first hike in 17 years is not the beginning of a sharp tightening cycle like the one recently seen in the United States and Europe. Nevertheless, the opacity of its guidance on future policy has led to a decline in the yen. The persistent insistence on maintaining loose conditions disappointed some investors looking for more aggressive rate outlooks, with the 10-year benchmark bond yield falling alongside the currency.
The central bank’s forward guidance does not offer a straightforward way to determine the pace of rate hikes, although the BOJ keeps the door open for another rate hike later this year.
By ending the negative rate imposed in 2016, Ueda has turned the page on the BOJ’s experimental monetary easing program after years when the Bank of Japan was a global outlier. The central bank’s decision to increase borrowing costs comes when its counterparts worldwide consider lowering their rates after historically aggressive tightening campaigns.
High rates and a strong currency in the United States have kept Japanese 10-year yields and the yen under pressure. Yields fell to 0.725% after the decision, contrary to some expectations that they would rise with a rate hike and the removal of yield curve control.
The dynamics between Japanese and U.S. rates are expected to continue despite the BOJ’s hike, given the persistent strength of the U.S. economy. The policy shift is expected to benefit Japanese banks, some of which could achieve returns on equity close to 8%.