The Bank of Japan is likely to keep its ultra-low interest rates because of steady wage growth, not because the yen is going up and up. This is because policymakers are still holding on to the hope that a tight job market will eventually boost consumer demand.
Since Japan’s economy is still weak, the BOJ is not likely to raise interest rates in the near future. This is true even if it puts more pressure on the yen, which has fallen to 32-year lows against the dollar and caused businesses to pay more for imports.
But the focus could shift to the BOJ’s controversial bond yield cap in April of next year, when companies and labour unions set wages for next year that will reflect the rise in inflation in 2022, say four people familiar with the central bank’s thinking.
Governor Haruhiko Kuroda’s second five-year term will also end in April. Analysts say this could mean a slow shift away from his radical stimulus plan.
One of the sources said, “It’s a once-in-a-lifetime chance for Japan to finally start a positive wage inflation cycle.” ” It’s also a crucial time for the BOJ to decide what to do with its yield cap. ”
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Investors are on high alert to see when the BOJ will change its policy of setting negative short-term rates and capping the yield on 10-year bonds around zero, which makes it stand out as a dovish central bank among the rest of the world.
If the BOJ wanted to change YCC, the most likely first step would be to either raise the 10-year yield target or widen the implicit 50-basis-point band around it.
There could be big effects on the market. Even a small increase in the yield target could cause a huge sell-off of bonds because it would mean the BOJ would stop putting a cap on the 10-year yield by offering to buy as many bonds as it wants.
LOW RATES, NOT FOREVER
The BOJ can’t raise interest rates to stop the yen from falling because the Japanese government, not the central bank, is in charge of exchange rate policy.
But that doesn’t mean that Japan will always have low rates. The BOJ’s carefully worded guidance gives it room to change the YCC targets before inflation stabilises at 2%, as long as it keeps overall monetary conditions loose.
Some BOJ officials think that YCC could be changed next year if wages go up enough and make it more likely that demand-driven inflation will be around 2%, sources said.
A second source said, “The key is whether wages, income, and consumption go up.” “If they do,” the source said, “it could be time to talk about a policy change.”
Even though wages haven’t gone up much in the past few years, this time could be different. A wave of price increases has been caused by the high cost of raw materials. In September, consumer inflation was above 2% for the sixth month in a row.
A recent survey showed that companies think inflation will reach 2% in five years. This may be a sign that Japan is finally getting out of its deflationary rut.
The main umbrella union in Japan, Rengo, said it will ask for pay raises of about 5% next year to make up for rising prices. This is more than the 4% increase it asked for this year.
Analysts say that even though wages have only gone up by 2% so far this year, the union’s high goal and Kishida’s focus on raising pay put pressure on companies to do the same.
A third source said, “The outcome of wage talks will be very important for figuring out the BOJ’s policy outlook.” “There’s hope that things will get better than they have in the past.”
For now, Kuroda is ignoring the public’s criticism and doubling down on YCC. He is betting that the recent cost-driven inflation will not last long, and he is warning of the possibility of a global recession.
The BOJ’s nine-person board also can’t agree on how quickly the bank should stop giving out stimulus. In April, dovish board member Asahi Noguchi said that wages would have to go up by almost 3% before the BOJ would change its very loose policy.
But people are becoming more opposed to YCC as the weak yen drives up the cost of living. This puts Prime Minister Fumio Kishida under the microscope in parliament.
Even though the BOJ has been buying bonds aggressively, the yields on super-long bonds have risen to levels not seen in years. This makes it hard to believe that YCC is working.
As Kuroda leaves, the public mood is changing, and there are more and more signs that inflationary pressure may last longer than expected. This could make the BOJ board more likely to at least talk about changing YCC.
A fourth source said that “it’s not clear how long the BOJ should keep doing what it’s doing now.” “It’s a problem that could get worse in the coming year.”
