Bank of Japan raising inflation forecasts will be ‘a signal’ for future rate hikes: Economist
I would agree that uh the BOJ has a very difficult job at the moment. Inflation is looking sticky. The real economy isn’t looking so great. So that doesn’t really leave you with any good options. A central bank wants to see inflation that is driven by a strong domestic economy, strong uh demand, strong wage growth. So where the indicators essentially move in the same direction, but right now they’re moving in opposite direction, which is a little bit like how you would typically characterize a stackflation uh scenario. And in that sort of scenario, there’s really no good choice. The BOJ has to decide which of the two to focus on. Do they want to focus on the domestic economy uh support growth uh by keeping interest rates unchanged? That might have uh the downside of exacerbating yen weakness and keeping inflation sticky or even uh see inflation reacelerate. Or do they focus on inflation and raise interest rates to bring inflation down? But at the same time, you end up killing domestic demand and um that is not great either, right? So there are no good options, which is also one of the reasons why we would say they’re probably going to keep interest rates unchanged today. But it’s an interesting meeting regardless for the reasons uh Lynn outlined, right? Um it will be interesting to see how Governor WA talks about the trade deal and uh what the board members new inflation forecasts will be showing. Mhm. Indeed. I see that while you believe that there could be a chance of a move in December, they at this stage a baseline is no move until January. I mean, the Bank of Japan isn’t exactly known for moving fast on anything, but January is a long way off, and you’ve got in the meantime a number of other major economies around the world, which could get a few more uh interest rate cuts under their belt. Might they miss the window on all of this? It’s a good a very good question. Um um I think it comes back down back to what we discussed at the top, right? It’s just very hard to say what they should be doing right now other than being cautious. um if central banks abroad cut rates uh and the BOJ stays on hold in principle that should bring down the interest rate gap between Japan and the rest of the world and hopefully that will help the yen exchange rate a little bit but it comes back to you know the key threats to the outlook right now and I would argue that the trade picture is still very very uncertain. It’s true we now have a trade deal, but if you think uh and if you think that a trade deal is better than no deal, then maybe that’s good news, right? Considering that the BOJ had previously flagged that as one of the key reasons for being cautious, but a lot about the trade deal is still unclear. Washington and Tokyo have a very different understanding of what the deal includes. Trade talks elsewhere between the US and other trading partners still need to be worked out. So the trade outlook overall is still incredibly uncertain and I think it would be hard to argue um that Japan is out of the woods and that now is the time for rate hikes. I think what matters more is uh the inflation forecasts if the BOJ goes ahead and raises the inflation forecast not only for this fiscal year but perhaps also the next fiscal year and the one after. That could be a signal that they’re getting ready to hike interest rates. So that’s something we should we should watch out for. Yeah, the Japanese yen hit its high of the year back in April. you know, all in the middle of sort of, you know, the um the tariff tantrum, if you like, and yet we’re now back at 149, as Lynn was saying. Do you expect further weakening of the Japanese yen from here, or do you think the prospect of further rate hikes might put a little bit of a a floor under it? It’s a very good question. I would say in principle, the yen should strengthen because relative to rate gaps and uh economic fundamentals, it’s just incredibly oversold. But it’s true that trading these last couple of weeks has moved in the opposite direction and it’s often very very hard to square with uh with fundamentals. It might um you know bring forward bring forward interest rate hikes. The BOJ has in the past been concerned when the yen weakens uh too much but so long as we stay below 150, I don’t necessarily think that uh we would we would uh we we would get we would get into that sort of situation. Uh the BJ is also concerned about surprising markets. uh they’ve done that in the past sometimes I think unintentionally and I don’t know that there’s a lot of appetite for that at the moment. Stefan I wanted to ask you about the political impacts here because if you look at virtually what every analyst is saying in terms of the bank of Japan they will talk about the trade side of things and then the other will be uh that they will cite the political uncertainties. Can you give us a bit more context about how that could impact the bank of Japan which is supposed to have dur independence but perhaps what are some of the indirect impacts here and if we are thinking about an ishiba that will step down with a san teichi set to potentially come uh into power isn’t this the window or these few months the window for a potential move is again a great question um there’s a lot of concern about that particular aspect ect of what’s going on in the Japanese economy. Right now, there’s a lot of uh concern about how Prime Minister Ishba’s loss of the upper house election affects policym going forward and how that will feed into um monetary policym right is he going to stay? Is he going to go? Is he going to work with the opposition or will the opposition form an alternative government? And um the reason people are concerned about that is because the opposition has pushed for consumption tax cuts to ease cost of living concerns. But a lot of investors seem to have taken the view that that would generate runway fiscal spending and perhaps uh pressure on the BOJ not to uh hike interest rates. The fact is though that if you look at the parties most likely to collaborate with the ruling coalition, no matter who the prime minister is going to be, right, um or which parties are, you know, most likely to form an alternative government if that happens, the proposals they’ve put forward, they’re all very very modest. they don’t really cost much more than the cash transfers that Prime Minister Ishiba has announced um reluctantly and belatedly. So, um there’s not the likelihood of big fiscal shifts is pretty low. If they do happen though, I wouldn’t necessarily think that that is a negative for the BOJ because you need to remember the BOJ looks for a strong domestic economy, demand driven price pressure of which we do not really have uh very much at the moment. a stronger domestic economy would give you a modicum of that demand-driven price pressure which could even bring forward some interest rate hikes. So, um there’s lots of moving parts to this to this picture. I wouldn’t necessarily think that a change of prime minister would uh rule our future future interest rate hikes. And I wanted to pick up as well on the consumption tax because yes, there’s been quite a lot of focus and we’ve seen also the moves in terms of JGB yields. uh yesterday as well uh this interesting development with the Japanese government decision to scrap this longstanding provisional gasoline tax as well. And certainly there’s some market watchers who would argue that this is an example of uh the Ishiba government having to make these compromises and potentially uh having to compromise more ahead in terms of a cut to the sales tax. But you were just saying that you don’t believe that the risk is as perhaps um you know significant as as some are characterizing it. Yeah, I mean I do I do understand the concern, right? Uh I just think if you look at the numbers, most of it is peanuts really. It’s small shifts here and there. It doesn’t really change the fact that Japan has undergone a fairly substantial fiscal contraction between 2022 and 2024. And the government balance is now essentially in balance. That’s the first time that I’ve seen that. Certainly in my career covering covering Japan, fiscal metrics are in the best shape in in decades. So I think what’s happening in bond markets always needs to be put in that context. We have inflation that is sticky. Um as you as you explained it at the top, Lynn, right? And bond markets are pricing that in. Uh inflation being sticky causes bond bond bond yields to drift up and real bond yields by the way are still negative. If uh the JGBs or Japanese assets overall were to trade like uh a distressed assets, you wouldn’t you wouldn’t see negative real rates. What is happening right now is just a reflection of the change that the Japanese economy is going through. So, lots of different things coming coming together. Um there’s another is another aspect to this, right? We also want to see how the BOJ might react and perhaps uh adjust its its balance sheet reduction because of market hiccups. If market trading does get unruly, right now it isn’t I would say, but if it does get unruly, will it stop uh will it stop selling bonds? Will it increase buying? Uh those are possibilities that we should pay attention to.
Stefan Angrick of Moody’s Analytics says the Bank of Japan is in a difficult position as the economy looks to be in stagflation, and domestic politics are unlikely to drastically change Japan’s trajectory of interest rates. He adds that the U.S.-Japan trade deal is still ‘extremely uncertain’.
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