Ichiro Suzuki
On March 19, the Bank of Japan has raised its interest rate paid to commercial banks’ deposits with the central bank for the first time since 2007. On the surface it was a baby step of a 0.1% move. With a hike to zero percent from -0.1%, however, the BOJ has finally lifted itself out of negative interest rates. At the same time, the BOJ has announced termination of asset purchases, of exchange traded funds (ETFs) and REITs to be specific. The central bank has also scrapped ‘yield curve control’ that has fixed the long end of the curve at targeted levels though the BOJ may still intervene in long-term interest rates, to keep them from rising rapidly.
Dr. Kazuo Ueda has been widely expected to make these actions when he became BOJ governor a year ago, and he did it. Developments in the economy in recent years have helped him do it. The pandemic has reawakened long dormant inflation in the global economy. The yen’s rapid fall as a result of the Fed’s aggressive actions became an additional factor to rekindle inflation. In response to the government’s call for higher wages and salaries hikes, Corporate Japan has given workers what they requested for two springs in a row. Average wage hike this spring at 5.2% is the highest since the outset of the 1990s. One the other hand, inflation has been running even higher until recently, driving real wage hikes into a negative territory. Negative wage growth has caused considerable dissatisfaction among voters against the ruling Liberal Democratic Party. A year ago, Corporate Japan already responded to Prime Minister Kishida’s call for higher wages with a 3.7% hike on average, but small and medium enterprises were not able to keep up with large corporations due largely to their thin profit margins and weak balance sheets. In 2024, however, there are signs that SMEs are following large ones. Otherwise, they wouldn’t be able to recruit and hold onto good people amid acute labor shortages.
From a broader perspective, the end of the age of negative interest rates is the first step to force much needed restructuring of the economy. Higher interest rates weed out weak companies that have been kept alive on extremely low rates. They would contribute to greater productivity in the economy since SMEs have been dragging down the overall economy’s productivity. But can the BOJ really do it? Aggressive tightening is prohibitive politically due to the pains it causes.
There has always been a question of how high the BOJ can go. Since the turn of the century, they have erred twice with a rate hike that later turned out to be a move that shouldn’t have been made. In the late 1990s the central bank went into ultra low interest rates in response to a banking crisis and a series of rolling recessions that came with it. In 2000, the BOJ under Governor Hayami made the first move to reverse such a policy believing the Japanese economy had regained its health, only to find the U.S. economy slipping into recession on the burst of the late 20th century tech bubble. The BOJ was forced to move back into ultra low rates. Then Governor Fukui even embarked on an experiment of negative interest rates that was truly creative by the standard of that time. After several years, Japan’s banking system was cleaned up at last and the economy was growing again, in no small part assisted by growing demand from China. The stock market responded to such favorable fundamentals. In 2007, Governor Fukui exited his negative interest rate experiment, declaring a victory. By that time, however, in a small corner of the U.S. financial markets, a mega crisis was brewing on rising default rates of sub-prime mortgages. Then, what happened in the economy is already a history. Fed Chairman Ben Bernanke, who advocated aggressive printing of money to keep the Japanese economy out of deflation, went into quantitative easing that far exceeded Governor Fukui’s experiment. The Fed’s ‘insanely’ aggressive easing made the BOJ look lukewarm, driving the yen higher against the dollar, thus exacerbating deflationary pressure on the Japanese economy. Lessons from the Global
Financial Crisis drove the BOJ under Governor Kuroda to emulate the Fed, flooding the markets awash with liquidity.
By the end of Governor Kuroda’s ten-year tenure, calls for getting out of negative and zero interest rates grew. Governor Ueda duly delivered it in March. The Fed, on the other hand, is widely expected to reduce interest rates after Chairman Powell’s aggressive responses to inflation had run its course. The U.S. economy may or may not be sitting on the cusp of next recession while the market overwhelmingly expects soft-landing.
A problem stands in the way of the BOJ’s attempt to normalize interest rate structure. It is the Japanese economy’s low body temperature. It is considerably lower than that of the U.S. Japan’s temperature starts rising from a much lower level than the U.S., and rises only slowly. By the time the Japanese economy feels that temperature has risen enough to allow a rate hike, it is already heating up in the U.S. and the Fed has made great efforts to keep it from overheating. The speed gap between the two economies always makes it tricky for the BOJ to move to a tighter monetary policy. The Fed’s next cycle is down definitely. It remains to be seen if the BOJ is capable of delivering a series of rate hikes for normalization. This seems like an uphill battle. Even if the U.S. economy manages to soft-land, the BOJ might back off from higher rates in the face of some signs of already cooling U.S. economy and the relatively dovish Fed.
About the author: Mr. Suzuki is a retired banker based in Tokyo, Japan.
