The Bank of Japan took a "hawkish" approach and announced both interest rate hikes and balance sheet reductions, demonstrating its determination to normalize policy.
On Wednesday, July 31, the Bank of Japan announced its latest interest rate decision, which raised the policy rate by 15 basis points to a range of 0.15%-0.25%. The Bank of Japan passed the rate decision with a 7-2 voting ratio, which was previously expected to remain unchanged by the market. Meanwhile, the Bank of Japan announced plans to reduce the scale of government bond purchases by 400 billion Japanese yen per quarter, and will no longer provide a range for bond purchases, but a specific amount. The Bank of Japan voted unanimously to reduce the scale of bond purchases, but not to the extent of the expected 1 trillion yen per month reduction.
Meanwhile, the Bank of Japan announced plans to reduce the scale of government bond purchases by 400 billion Japanese yen per quarter, and will no longer provide a range for bond purchases, but a specific amount. The Bank of Japan voted unanimously to reduce the scale of bond purchases, but not to the extent of the expected 1 trillion yen per month reduction.
The new guidelines for currency market operations will take effect on August 1, 2024. Analysts believe that:
The Bank of Japan pointed out that the inflation risk may increase in the next two years, which may be the reason why it took action. If this prospect is proved to be correct, the Bank of Japan may further raise interest rates.
After the announcement, the yen against the dollar violently fluctuated in the short term, falling below 153 at one point. The Nikkei 225 Index continued to fall after the Bank of Japan's decision, and the 10-year Japanese government bond futures narrowed their intraday decline after the Bank of Japan announced the interest rate cut.
"Surprisingly" raising interest rates, and balance sheet reduction "less than expected".
The Bank of Japan's "super expected" interest rate hike this time, and the market expects the possibility of an interest rate hike in July to be only about 40%; while the reduction of the balance sheet is not as expected, the market generally expects the purchase amount to decrease to 5 trillion yen next month, and ultimately cut in half within two years.
Specifically:
Currently, the monthly bond purchase scale is about 6 trillion yen, and the monthly bond purchase scale in July was about 5.7 trillion yen. From August to September, the monthly bond purchase scale is about 5.3 trillion yen. The monthly bond purchase scale from October to December is about 4.9 trillion yen...
By the first quarter of 2026, the monthly bond purchase scale will be about 3 trillion yen, and the holding amount of Japanese government bonds is expected to decrease by about 7-8% by mid-2024.
The Bank of Japan also stated that the interest rate applied to the balance in the current accounts held by financial institutions at the Bank of Japan is 0.25%; it will reduce its bond purchase in a predictable manner, and it will announce the scale of bond purchase every quarter and adjust the bond purchase plan as necessary; in June 2025, the bond purchase will be subject to midterm evaluation, and if necessary, the bond purchase plan will be evaluated at the policy meeting.
It is worth mentioning that before the announcement of the news, Japanese media had "leaked" news that NHK, Nikkei News, and Jiji Press all pointed out the Bank of Japan's possible interest rate hike action, and the bond purchase schedule for August-September was also announced as scheduled, with the amount of bond purchases reduced compared to before.
There is an upward risk in prices, or further rate hikes.
The Bank of Japan stated:
As economic prospects change substantially, it will adjust its policy of easing, and the actual interest rate is significantly low.
If the inflation prospect comes true, the Bank of Japan will continue to raise interest rates, and the wage growth will be significantly higher than that of last year. In fiscal years 2024 and 2025, the price risk is biased towards an increase.
On the inflation forecast, the Bank of Japan slightly lowered the core CPI for fiscal years 2024/25, and kept the non-energy core CPI unchanged:
The core CPI for fiscal year 2024 is 2.5%, previously predicted as 2.8%; the core CPI for fiscal year 2025 is 2.1%, previously predicted as 1.9%; and the core CPI for fiscal year 2026 is 1.9%, previously predicted as 1.9%.
The non-energy core CPI for fiscal year 2024 is 1.9%, previously expected as 1.9%; the non-energy core CPI for fiscal year 2025 is expected to be 1.9%, which was previously expected to be 1.9%; and the non-energy core CPI for fiscal year 2026 is expected to be 2.1%, which was previously expected to be 2.1%.
Meanwhile, Japan also stated that:
The exchange rates of the Japanese yen are more likely to affect prices than before, with import prices rising again, and we must be vigilant against the risk of excessive inflation.
In addition, despite the impact of prices, private consumption still has elasticity, and recent corporate behavior is gradually shifting towards raising wages and prices.
The loose monetary policy environment will continue to support the economy, and the real interest rate is expected to remain significantly negative.
Will the Bank of Japan take another "hawkish" step?
Analysts believe that this interest rate decision is not dovish. The Bank of Japan has pledged in writing to further raise interest rates if the good conditions of economic activity and inflation prospects continue. This is the first time and the hawkish stance of the Bank of Japan that we have seen under the leadership of Haruhiko Kuroda. As for the scale of bond purchases, Nick Twidale, an analyst at ATFX Global Markets, believes that the Bank of Japan's bond reduction scale is far lower than expected, which has dealt a heavy blow to the yen.
However, analysts Toru Fujioka and Sumio Ito believe that the weakness of the yen has come to a turning point:
The Bank of Japan raised its policy interest rate and also said it would reduce its monthly bond purchases to about 3 trillion yen in the first quarter of 2026. Governor Haruhiko Kuroda has also expressed the bank's willingness to continue the normalization process, and Wednesday's action may fuel speculation that another rate hike may occur later this year. The hawkish stance of the Bank of Japan just a few hours before the Federal Reserve's meeting may signal a turning point for the struggling yen, as traders believe the gap between US and Japanese interest rates will narrow. Any hint from the Federal Reserve that it may cut interest rates in September will support this view.
Izuru Kato, chief economist at the OTAN Research Company, said:
The decision to raise interest rates is likely to correct the excessively loose monetary policy and reflects the fact that the actual policy interest rate has deepened into negative territory. Although the Bank of Japan has always explained that monetary policy is not aimed at the exchange rate, the weakness of the yen has certainly been an important factor behind today's decision given the impact it has had on small and medium-sized enterprises in rural areas of Japan. The rate hike is symbolic and there is no need to worry about the pace of future rate hikes, as the Bank of Japan's rate hikes in March and July only reached the magnitude of a normal central bank's rate hike. This does not mean that the Bank of Japan has suddenly turned hawkish. Looking ahead, the Bank of Japan will still be cautious and avoid tightening policy too hastily.
Editor/Somer