Japan to raise interest rates for the first time in 17 years

The Bank of Japan (BoJ) is preparing for its first interest rate hike since February 2007, marking a turning point in its long-standing monetary easing policy following significant wage increases agreed upon by major companies and unions during this year’s spring wage negotiations, known as “Shunto.”

While central banks like the Federal Reserve (Fed), the European Central Bank (ECB), and the Bank of England (BoE) have been raising interest rates to curb record-high post-pandemic inflation, the BoJ has continued its ultra-loose monetary policy.

Following indications of potential significant wage increases during spring wage negotiations between unions and employers in Japan, expectations have emerged that the BoJ may conduct its first interest rate hike since February 2007 and abandon its negative policy interest rates.

Eyes are now on the BoJ’s monetary policy meeting scheduled for March 18-19 with expectations that the Bank may exit negative interest rates due to expectations of ending inflation challenges and achieving price stability.

While some analysts anticipate a policy move from the BoJ next week, there is also discussion that the Bank may assess wage negotiations between unions and employers and implement the first interest rate hike in April.

Current monetary policy in Japan The BoJ stands out globally as the only central bank applying negative interest rates, symbolizing significant monetary expansion.

Conducting monetary policy meetings eight times a year, the BoJ updates the economic outlook in January, April, July, and October.

Despite core inflation in the country exceeding the 2% target, the BoJ continues its excessively loose monetary policy.

Persistent negative interest rates have challenged banks’ profitability, limiting lending capacity and investments. Concerns about the yen depreciating under continuous negative interest rates have also arisen, jeopardizing consumer and investor confidence.

Since February 2016, the Bank has implemented a negative 0.1% policy interest rate to encourage borrowing, spending, and healthy price increases.

However, the BoJ has been laying the groundwork for ending negative interest rates since the end of last year.

At its January meeting, the Bank maintained its policy interest rate and did not make any changes to its yield curve control regime.

BoJ Governor Kazuo Ueda mentioned after the meeting that monetary policy would remain extremely loose for now, implying that future interest rate hikes would be very mild.

Macroeconomic situation Recent stagnation has been observed in Japanese stocks amidst the yen’s strengthening against the dollar and the country’s 10-year government bond yields reaching the highest level in three months.

High inflation, despite robust capital spending, poses a risk to domestic demand and private consumption, limiting a delicate growth balance.

The country’s economy narrowly escaped technical recession by recording a 0.1% quarter-on-quarter and 0.4% year-on-year growth in the last quarter of last year.

While the Consumer Price Index (CPI) rose by 2.2% year-on-year in January, core CPI increased by 2%, exceeding expectations. Higher-than-expected inflation data has increased expectations that the BoJ may end its negative interest rate policy.

Further acceleration in inflation in February and providing space for the BoJ to end negative interest rates are expected.

Expectations from future meetings BoJ Governor Kazuo Ueda has stated that wage negotiations will play a “critical” role in the decision to end negative interest rates.

Recent hawkish comments from Bank officials and significant wage increases agreed upon by major companies and labor unions have raised expectations of a policy change.

After ending negative interest rate policies, it is anticipated that the BoJ will adopt a “wait-and-see” approach to assess the impact on inflation-adjusted real wages before proceeding with further policy normalization.

Ending negative interest rates is expected to also end Japan’s policy of keeping the 10-year government bond yield at 1%.

The BoJ’s exit from negative interest rates is expected to not only affect companies and households but also global capital flows.

Why are wage increases important? The BoJ views strong wage increases as an important precondition for moving away from the long-standing zero interest rate policy, as higher wages will increase purchasing power and make inflation more sustainable by focusing on wage trends.

Expectations of wage increases at the highest levels in Japan in 33 years have raised expectations that the BoJ may end negative interest rates.

Analysts anticipate that, due to sustained inflation above the BoJ’s 2% target for over a year and sustainable wage increases, the central bank is now expected to move towards policy change.

Meanwhile, reports in the Japanese media suggest that the BoJ has made final adjustments to end negative interest rates at its upcoming monetary policy meeting.

source: prepared by Melisa Beğiç

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