The BoJ Inches Closer to Normal

Two central banks convened Wednesday and—perhaps unsurprisingly—the one doing nothing stole all the headlines. Yes, the Fed held, but Fed head Jerome Powell declared a rate cut “could be on the table as soon as the next meeting in September.” Headlines cheered, but we don’t see the fuss, considering Powell left plenty of wiggle room. Decisions are still data-dependent and, in our view, unpredictable. More interesting, in our view, is the Bank of Japan’s (BoJ’s) decision to hike its policy rate to 0.25% and taper its quantitative easing program. Monetary policy there is slowly returning to normal, which we think is an incremental positive.

To say Japan is a monetary policy outlier these days is an understatement. The Fed started hiking rates in early 2022, ratcheting the fed-funds target range from near zero that March to 5.25% – 5.5% in July 2023. The BoE and ECB followed similar courses, with the latter making its first cut in June. But Japan’s policy rate was negative until March 2024. And even then, the small hike brought it to just 0.0% – 0.10%.

Similarly, the Fed, BoE and ECB have not only long since stopped buying bonds, but they have been running down their balance sheets. But even after scrapping its long-term interest rate target (which entailed “unlimited” bond purchases at times) in March, the BoJ is still gobbling up long-term assets.

As a result, Japan’s long and short rates are well below the rest of the world. The 1.06% 10-year Japanese Government Bond (JGB) may be high relative to the last decade’s history, but it pales next to US Treasurys (4.03%), UK Gilts (3.97%) and many others.^[i]

For Japan, this pinches hard. All else equal, money moves to the highest-yielding asset. So Japan’s low rates made money flee the yen, bringing it to generational lows versus the dollar. This isn’t a massive economic headwind. But it creates winners and losers. And the winners have been Japan’s export-heavy multinationals, which can reap big profits from currency translation when the yen is weak. Domestically focused businesses and households haven’t fared as well: A weak currency makes imports more expensive, which pressures people in a nation that imports the bulk of its energy. This isn’t the only reason domestic demand components of GDP have fallen lately, but it contributes.

Hence, the BoJ’s moves. Citing currency factors, Governor Kazuo Ueda and his team inched the policy rate to 0.25% and announced they will reduce monthly JGB purchases from ¥6 trillion to ¥3 trillion by Q1 2026. That amounts to a quarterly reduction of ¥400 billion, or about $2.7 billion at current exchange rates. The move wasn’t a huge surprise, as the BoJ announced loose plans to taper asset purchases in June, but now we have a schedule.

We often tell readers not to overrate Fed and other major central banks’ moves. And that still holds. For instance, we don’t think it matters much whether the Fed cuts in September, given markets and the US economy are doing fine at higher rates. A small cut won’t do much to change the price of money in practice. But the Fed and its ilk have been operating in the world of more normal monetary policy for a while now. Back when asset purchases were going full tilt, we noted numerous times that it was artificially flattening the yield curve, which is the opposite of stimulus. When the Fed decided to taper, then end asset purchases—and then start shrinking its balance sheet—we cast them as incremental positives. Returns to normal. Now Japan is embarking on that same return, however gradually.

We have seen some chatter that these moves shift fundamentals within Japanese stocks, benefiting domestically focused firms over export-heavy multinationals. Thursday’s volatility, which hit some exporters and tourism-reliant companies hard, probably reflects that sentiment to some degree. However, the reaction seems a bit hasty. One, Japanese rates are still well below the rest of the developed world. Two, the yen isn’t exactly surging. It strengthened from its low of 161.67 to the dollar on July 1 to 150.46 after the rate hike Wednesday, which puts it back at February levels.^[ii] That is still very, very weak relative to Japan’s history. It still means ripe currency conversion profits for exporters, and it still pressures households. And it likely extends the mismatch between rising export values and falling export volumes. Only the latter provides a lasting domestic economic boost. Hence, the backdrop probably still favors the big multinationals.