News & Analysis

The Bank of Japan hiked interest rates for the first time in 17 years today, effectively exiting negative interest rates that had been in place since 2016 as it judged that the virtuous cycle between wages and prices has become more solid such that the price stability target of 2% will now be achieved by end-FY25.

In doing so, the Bank has moved from a three-tier system that has been in place since 2016 (basic balance (+0.1%), macro add-on balance (0.0%) and policy-rate balance (-0.1%)) to a one-tier system whereby an interest rate of 0.1% will be applied to all balances. This should effectively keep the short-term money market rate (TONA), now the de facto policy rate, in the range of 0-0.1%, effectively resulting in a 10bp rate hike. In addition to exiting NIRP, the Policy Board also voted in favour of scrapping its yield curve control framework that had been gradually wound down since December 2022 and also abolished its fixed purchases of ETFs and Japanese real estate investment trusts (J-REITs). Furthermore, it noted that its overshooting commitment has been fulfilled, meaning its monetary base is no longer required to expand year-on-year.

However, despite the normalisation efforts, the Bank aimed to dilute the hawkish message through multiple avenues.

On the balance sheet, despite exiting YCC, the lower range in its quarterly schedule of outright JGB purchases remains unchanged at JPY4.7trn per month. Furthermore, the Bank stated that the actual pace of purchases will be “broadly the same as before”, a pace that it estimated at JPY6trn per month in a footnote. Moreover, in the case of a rapid rise in long-term interest rates, the Bank expressed that it stands ready to conduct emergency purchases of JGBs despite the 1% soft cap on the 10-year being removed.

The most important dovish connotation took place in its forward guidance, however. The BoJ highlighted that it “anticipates that accommodative financial conditions will be maintained for the time being”, suggesting that today’s decision is unlikely to be the first of a series of normalisation efforts.

While this “dovish hike” outcome was broadly anticipated by markets, some speculative short JGB and USDJPY positions have still been shaken out of the market. This has led USDJPY to rally north of the 150 handle, to trade just shy of levels where the pair has recently stalled on the risk of stealth intervention.

With markets squarely focused on fewer rate cuts from the Fed this year, we expect USDJPY to continue hovering around this level until month-end barring any dovish surprise from the Fed tomorrow evening.

Bank of Japan sees the virtuous cycle satisfied, but maybe not fulfilled 

While some sell-side analysts, including ourselves, believed that the Bank of Japan would want further guidance on the outcome of the Spring wage negotiations before abandoning YCC and exiting NIRP, such as the outcome of the services wage negotiations on April 4th, members of the Policy Board were happy with what they’ve already seen as the largest union in Japan announced an average wage increase of 5.28% this year on Friday, up from 3.8% last year. For most within the Executive Board, this was enough for the BoJ to exit its ultra-loose policy stance, however, the decision was not unanimous. 2 members of the 9 strong Board voted against hiking rates. Nakamura Toyoaki, who voted against exiting NIRP and YCC, did so on the basis that it was not yet visible that small and medium-sized businesses were hiking wages with similar vigour to large corporates where union coverage is most concentrated. Noguchi Asahi, on the other hand, dissented against hiking rates at the same time as abolishing its YCC framework, favouring sequencing the approach to allow more time to observe the virtuous cycle between wages and prices.

In our view, the lack of unanimity within the Policy Board on the progress of the virtuous cycle and the dovish guidance by the BoJ that “accommodative financial conditions will be maintained for the time being” suggests that the minimum requirement for policy normalisation has only just been met. That is, higher inflation filtering into higher wage growth, at least in some parts of the economy.

For subsequent hikes to be achieved, we suspect the BoJ will need further confidence that the breadth of wage increases has increased and has fed back into stronger services inflation, thus sustaining higher structural levels of inflation. We don’t expect this to become visible within the data until at least October’s decision, which we currently see as the earliest possible meeting for the BoJ to hike once again as it also updated its Economic Outlook. The spaced out sequencing of tightening steps will also allow the BoJ to observe the functionality of the bond market after officially abandoning YCC, especially in response to data showing inflation likely becoming more embedded in the economy.

With yields now flexible, the BoJ has more firepower to defend the yen 

Under our base case of no subsequent hikes until Q4, we suspect USDJPY will continue to trade at the mercy of developments in US yields. However, unlike the past 24 months, the Bank of Japan now finds itself with more tools in its arsenal to defend sustained yen depreciation.

With JGB yields now allowed to flexibly adjust higher, as long as it is in a moderate manner, verbal intervention by policymakers will now be more effective as they can effectively guide expectations of future policy in a hawkish direction to support the yen.

This, along with the legacy threat of stealth intervention north of the 150 handle should keep USDJPY from breaking through its previous high of 151.90 in the event markets are forced to price out expectations of Fed easing further.

USDJPY breaks back above the 150 handle but the rally should be contained




Simon Harvey, Head of FX Analysis



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