Investors widely expected a historic interest rate hike that would bring borrowing costs to the highest level in 30 years.
The Bank of Japan is expected to announce its decision on Friday. This will be another step towards the long-awaited shift from an ultra-loose monetary regime.
Data from LSEG shows that markets are pricing in a 86.4% chance that the BOJ will increase its benchmark rate by a quarter-point to 0.75%. This level was last seen in 1995.
This would be a sign of the central bank’s commitment towards policy normalisation, after decades of fighting deflation by using near-zero interest rates or negative rates and massive bond purchase.
Market to focus on Governor’s comments
A rate hike would be a significant moment in the history of the BOJ. The BOJ has only recently started to dismantle the framework that governed its monetary policies for a generation.
Even after the expected increase, policymakers still believe that real interest rates will be negative, indicating further tightening may follow.
Min Joo Kang is a senior economist at ING Think for South Korea and Japan. He said that a 25 bp increase has been priced in by the market participants.
The market will be focused on the comments of Governor Ueda. We don’t anticipate Ueda sending any hawkish signals, given the growing concerns over rising market rates.
BOJ Governor Kazuo Ueda, who has repeatedly urged caution, has noted the difficulty in estimating Japan’s neutral rate, which does not stimulate or restrain economic growth.
The central bank has placed the rate at a range between 1% and 2.5%, which highlights the uncertainty regarding the pace and the endpoint of future increases.
Gregor MA Hirt said that the markets would be scrutinizing the tone and details of the BOJ communication.
The immediate reaction is likely to be influenced by comments about currency weakness and signals about the terminal rate.
Global implications of a rate hike
The BOJ decision is closely watched by many people outside of Japan, in part because of the carry trade.
Investors have been borrowing cheaply in yen for years and investing the proceeds in higher yielding assets overseas.
A rate increase could strengthen the yen, reducing the appeal of such trading and potentially triggering changes in global capital flows.
This could help to reduce inflation in the home but also increase volatility on currency and bond markets abroad.
Vincent Chung, fixed-income portfolio manager for T Rowe Price said that the BOJ may raise rates twice by 2026 if rates are still negative.
He said that any yen weakness after cautious guidance was likely to be short-lived.
Growth concerns complicate the future
The economy is still fragile, despite the fact that inflation has exceeded the BOJ target of 2% for 43 consecutive months.
Revised data shows that Japan’s economy contracted more than originally estimated in the third-quarter, with a contraction of 0.6% on a quarterly basis and 2.3% on a yearlyised basis.
A stronger yen, and higher borrowing costs, could further weigh down on consumption and investments. This is even as policymakers attempt to strike a balance in controlling inflation and supporting economic growth.
The pressure on public finances is increased by the rising yields
The heavily indebted Japanese government will also be affected by higher rates.
Bond yields are at 18-year highs, with the 10-year Japanese government bonds yielding around 1.97%.
According to a recent Nikkei article, Japan’s borrowing cost could double if yields rose to 2.5%.
Interest payments are projected at 16.1 trillion yen by fiscal 2028 compared to 7.9 trillion yen fiscal 2024. This is despite the government implementing its largest stimulus package ever since the pandemic.
ING Think believes that recent market reactions to comments made about the neutral rate were overdone. The concept is inherently unreliable, the company said.
As it assesses how higher rates will affect the economy, the BOJ will closely monitor indicators like spring wage negotiations and lending activity.
This post Bank of Japan sets for landmark rate increase in 30 years; Markets to focus on BoJ’s comments may be updated as new developments unfold.
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