BoJ Takes a Small Step in the Right Direction

Tokyo took center stage on Tuesday, as the Bank of Japan (BoJ) raised its benchmark interest rate from -0.1% to 0% – 0.1%, concluding its 8-year experiment with negative rates. It also kinda sorta ended its Yield Curve Control (YCC) program, abandoning rate targets but continuing to buy Japanese Government Bonds (JGBs) at a fast clip. We don’t think any of this means much for markets, which long ago priced in a widely discussed move. But the partial return to normal is no bad thing.

Japanese banks have long bemoaned negative rates, which are essentially a tax on holding cash. While theory says this is an incentive to spend and invest instead of hoarding, banks—rightly, in our view—noted that taxing reserves while whacking loan revenues by squashing long rates was a massive disincentive to lend. This meant less capital flowing through Japan’s economy, which is a headwind to growth—the opposite of the intended stimulus. Bringing rates back above zero is a small but important step to restoring more traditional incentives.

Yet as long as the BoJ keeps meddling with long rates, the return to normal isn’t complete. Ending YCC is a step, we guess. The official cap on 10-year JGB yields had already risen from 0.1% to 0.25%, then half a percent, and most recently 1.0%. Past ceilings lifted as markets tested the BoJ’s resolve to defend its peg, and at each turn it caved eventually. Now, as it abandons explicit target rates, the 10-year JGB trades at 0.73%.^[i] There is a lot of talk about how this means the BoJ successfully normalized the yield curve, leaving the impression markets are now in charge.

But this seems off to us, because the overarching quantitative easing (QE) program of bond purchases continues, with the BoJ pledging to continue buying ¥6 trillion ($39.8 billion) of JGBs per month. So in a way, this new approach simply gives markets less clarity—we know the BoJ will be buying JGBs, but seemingly at arbitrary maturities to manipulate yields as it sees fit. It will still be exerting downward pressure on long rates, which will still interfere with lending incentives. In other words, this is still a case of the monetary beatings continuing until morale improves. On the bright side, markets are well used to this, and Japanese GDP has proven it can grow alongside suboptimal policy, so we don’t view it as a massive cyclical headwind.

There are also some international implications here. For the past few years, Japan has served as a real-life counterfactual for Western rate hikes. As the only central bank not raising rates, the BoJ created a control group for how inflation evolved without fast-rising short rates. Turns out it evolved just fine, slowing from a high of 4.4% y/y in January 2023 to 2.1% in January 2024.^[ii] Yes, even without rate hikes, the inflation rate more than halved as supply chains improved and energy prices eased. Services prices, currently the West’s big bugaboo, never really spiked—they just finally escaped deflation, gradually crawling to 2.2% y/y in January.^[iii] Japan’s experience strikes us as one more piece of evidence inflation in the US, UK, Europe, Canada and Australia improved despite rate hikes, not because of them—a point others are starting to argue lately, which is refreshing.

As for Japan, while Tuesday’s move was welcome news for businesses all over the country, judging from the range of responses, we don’t think it alters the country’s fundamentals. The long-running divide between domestically focused businesses and export-rich multinationals probably continues, with external demand being a big economic driver. The yen is still at generational lows, trading near ¥150 to the dollar, which lets exporters reap profits from currency translation but extends headwinds on companies that import components, resources and labor. Winners and losers, as with all currency moves. But it all amounts to extending the long-running status quo, just with a little less funky BoJ policy than the country had on Monday.