BOJ Ends Negative Rates With Dovish Triple Option Attack

Date: March 19, 2024

The Bank of Japan (BOJ) delivered a rate hike for the first time since 2007. The move was widely anticipated, following an overnight article by Nikkei, stating that the BOJ would forge ahead with a triple option attack of: 1) hiking rates; 2) ending Yield Curve Control (YCC); and 3) halting risky asset purchases.

Despite hiking rates, BOJ sounded a dovish note, anticipating that “accommodative financial conditions will be maintained for the time being”.

Bank of Japan: “Accommodative financial conditions will be maintained for the time being”

Our view was that the BOJ would exit YCC in March, hike rates in April and prepare to stop purchasing risk assets in June. However, the BOJ has clearly brought plans forward, following stronger than expected wage increases last week.

1. NIRP: BOJ set the policy rate in a range between 0.0% and 0.1%, putting an end to an era of Negative Interest Rate Policy (NIRP). The vote was not unanimous, with 7 out of 9 board members opting for a normalization. Only board members Nakamura and Noguchi dissented. The new rates will be effective from March 21, 2024.
2. YCC: BOJ removed the 1.0% upper reference level on 10Y Japanese Government Bond (JGB) yields, effectively ending YCC. However, the statement specified that the bank will continue to purchase JGBs as before. The amount of JGB purchases is currently around JPY 6 trillion per month. In case of a rapid rise in long-term interest rates, BOJ will increasing the amount of JGB purchases – hardly a challenge in the absence of upside pressure on 10Y yields. The decision was almost unanimous, with an 8-1 vote.
3. Asset Purchases: On risk assets, BOJ mentioned that it would discontinue purchases of Exchange-Traded Funds (ETFs) and Japan Real Estate Investment Trusts (J-REITs). The decision was unanimous. The BOJ did not specify whether/when it would reduce its holdings of ETFs and J-REITs. The statement also mentioned that the BOJ would gradually reduce the amount of corporate bond purchases and will discontinue the purchases in about one year.

What triggered the move?

Let’s be clear – it would not have been possible for Governor Ueda to secure enough votes to exit NIRP in March absent last week’s blockbuster wage increase. In this year’s Shuntō, Rengo (Japan’s largest trade union) announced the outcome of the negotiation at 5.3%, which is meaningfully higher than the previous high of 3.8% achieved in 2023.

This points to strong real wage growth in 2024. Recall that average monthly real cash earnings remained negative in 2023, given high inflation levels. But national CPI declined to 2.2% y/y in January, in line with a global disinflationary trend. This should continue at a more gradual pace in 2024. Core-core inflation, which was 3.5% y/y in January, should also converge towards headline CPI in the months ahead. That entails ~3.0% real wage growth in 2024.

BOJ has been waiting for a “virtuous cycle” to take hold. This is a process through which sustained imported (cost-push) inflation, fueled by JPY depreciation, results in changes to corporate behavior, such as rising wages and higher price setting behavior. In turn, that can boost domestic consumption and fuel endogenous (demand-pull) inflation.

Implications for investors

In spite of today’s prominent announcement, the BOJ will keep conditions accommodative to fend off uncertainties. The policy statement was very explicit, stating that: “there are extremely high uncertainties surrounding Japan's economic activity and prices, including developments in overseas economic activity and prices, developments in commodity prices, and domestic firms' wage- and price-setting behavior”.

We expect that the BOJ will pause after today. The difference between -0.1% and 0.0% on the overnight call rate is not that significant, while the impact of ~0.1% on government debt financing costs should be manageable.

We do not know for sure whether last week’s Shuntō will lead to a virtuous cycle, but the BOJ sounded quite sanguine about achieving this in 2024. The statement mentioned that “recent data and anecdotal information have gradually shown that the virtuous cycle between wages and prices has become more solid”. We have kept our 2024 GDP growth forecast unchanged at 0.8%. More time is needed on this front.

Bank of Japan: "Recent data show that the virtuous cycle between wages and prices has become more solid".

Although rate hikes should exert appreciatory pressures, we note that the JPY depreciated 0.76% to USDJPY 150.30 after the news. Going forward, the developments around the US Fed will be a bigger driver of volatility via rate differentials. The Nikkei 225 gained 1.19% to 4003.60.

Meanwhile, the 10Y JGB yield declined to 0.73% following the news. Global yields have peaked and we don’t anticipate that 10Y JGB yields will overshoot 1.00% in the near term.

This article is based on an earlier report by UBP