Compared to the market consensus, Deutsche Bank believes that the Bank of Japan will take a more hawkish stance on monetary policy.

On Tuesday, Kentaro Koyama, chief economist at Deutsche Bank Japan, released a report predicting that the Bank of Japan will raise interest rates twice this year (25 basis points each in July and December) and the policy interest rate is expected to rise to 0.5% by the end of the year.

Deutsche Bank believes that the actual GDP growth rate in Japan will be slightly higher than the potential level in the next 2-3 years. Compared to the forecast in March, Deutsche Bank slightly lowered its 2024 actual GDP forecast for Japan to 1.1%, but raised its 2025 forecast from 1.0% to 1.2%.

Deutsche Bank pointed out that core inflation will start rebounding in the fourth quarter of this year, and accelerated wage growth will promote sustained domestic consumer recovery.

In addition, Deutsche Bank predicts that the Bank of Japan will reduce its bond purchase size starting in July, which is also a clear signal of gradually exiting ultra-loose monetary policy.

Accelerated wage growth is expected to improve disposable income and consumption.

The income environment is still key to Japan's domestic demand recovery. Deutsche Bank expects Japanese households' real disposable income to rise this year, which is mainly due to several key factors:

First, the acceleration of wage growth will directly increase household income.

Data from the Japanese Trade Union Confederation (Rengo) shows that annual wage growth reached 5.2%, including a 3.6% increase in basic wages.

Deutsche Bank pointed out that this will bring Japan's nominal wage increase to 3%, but this growth will not fully reflect on actual wages until July, so actual wages are expected to accelerate in the third quarter.

In addition, slowing inflation means that the rate of decline in household purchasing power will slow down. The income tax reduction policy implemented from June will also further increase households' disposable income.

Deutsche Bank also predicts that due to the accumulation of a large amount of savings by households during the epidemic, actual consumption will begin to rise from the second quarter, and the growth rate of consumption expenditure will exceed the growth rate of disposable income.

Deutsche Bank pointed out that by the second quarter of this year, Japan's household excess savings will rise from 50 trillion yen in the fourth quarter of last year to 52.9 trillion yen (8.8% of GDP), and excess savings will remain at a high level of about 43.2 trillion yen (7.2% of GDP) by the end of 2025.

In other words, as economic activities are gradually normalized, households will begin to use the savings accumulated earlier, which will drive the growth of consumption and may further promote economic recovery.

Core inflation is expected to bottom out in the fourth quarter.

Deutsche Bank predicts that the core CPI (excluding fresh food and energy), known as the 'core of the core,' will bottom out at 1.5% in October, and then rise again. Due to the decrease in commodity inflation, the inflation rate has begun to slow down since it reached a year-on-year high of 4.34% in August 2023.

This forecast is mainly based on the factors of weak Japanese yen, widening output gap, and labor costs shifting to prices due to wage growth. Deutsche Bank predicts that unit labor costs will grow at a stable rate of 3.0-3.5% per year.

At the same time, Deutsche Bank predicts that inflation, including energy, is expected to accelerate by 0.7-0.8 percentage points year-on-year in 5-7 months due to the rise in electricity bills. However, Deutsche Bank pointed out that this is a policy-driven change and does not reflect the potential inflation level.

Two interest rate hikes this year?

Based on the predictions of economic growth, wages, and inflation, Deutsche Bank predicts that the Bank of Japan will raise interest rates twice in 2024: 25 basis points each in July and December, and the interest rate will rise to 0.5% by the end of the year from the current level of around 0%, which is the highest level in 30 years, to avoid overly loose financial conditions and further depreciation of the yen.

However, considering the currently high inflation expectations, the real interest rate will still remain in negative territory.

Based on this, Deutsche Bank further predicts that the Bank of Japan will continue to raise interest rates in the third quarter of 2025, raise the interest rate to 0.75%, and then raise the interest rate to 1% in the first quarter of 2026, close to the so-called 'neutral interest rate'.

According to the Bank of Japan's data, Deutsche Bank assumed that the natural interest rate would be between -1.0% and 0.5%. Considering the 2% inflation rate, the nominal neutral interest rate should be between 1.0-2.5%.

Deutsche Bank pointed out:

The financial market has not discounted the 1% interest rate over the next two years, so our interest rate forecast is still more hawkish than the consensus, but the market consensus seems to be approaching our forecast.

When will the bond purchases be reduced? June or July?

There are some differences among analysts on the timing of bond purchase reduction.

Deutsche Bank predicts that the Bank of Japan will reduce its monthly bond purchases to 50 trillion yen from July, and further reduce it to 30 trillion yen in January 2025.

According to some reports, the Bank of Japan may discuss reducing bond purchases at its policy meeting next week.

According to sources, the Bank of Japan may consider whether the current monthly bond purchase speed of about 6 trillion yen is suitable for slowing down, and whether it needs to provide more details about the outlook to improve predictability. The Bank of Japan will announce the latest monetary policy decision on June 14.

Sources also said that some investors expect the Bank of Japan to reduce its bond purchase scale this month, and then raise interest rates in July, but changes in bond purchase scale cannot guarantee any future policy path.

Editor/ruby