The Bank of Japan (BoJ) has raised interest rates for the first time in 17 years, hiking the short-term interest rate to between 0% and 0.1% (up from -0.1%).
Although it will continue purchasing Japanese government bonds, the bank will stop buying exchange-traded funds and real estate investment trusts, and will gradually reduce the amount of commercial paper and corporate bonds it buys, with a view to discontinuing purchases in a year’s time.
At today’s monetary policy meeting, the BoJ said it “assessed the virtuous cycle between wages and prices” and decided that its price stability target of 2% would be achieved “in a sustainable and stable manner”.
Corporate profits are improving, labour market conditions are tight and wages are likely to increase steadily this year. “The policy framework of quantitative and qualitative monetary easing with yield curve control and the negative interest rate policy to date have fulfilled their roles,” the BoJ announced.
The Japanese economy has recovered “moderately” although some weakness remains, so the bank anticipates that “accommodative financial conditions will be maintained for the time being”.
Ben Powell, chief Asia Pacific investment strategist at the BlackRock Investment Institute, observed: “The Bank of Japan's historic step of raising rates for the first time since 2007 marks an end to an extraordinary era of unconventional monetary policy aimed at pulling Japan's economy out of decades of deflation or low inflation and stagnating activity.
“A key reason for today’s decision was evidence of strong wage growth. The largest federation of trade unions, Rengo, last Friday reported that workers at the country's biggest firms are set to receive the most substantial wage hike in more than three decades.
“The BoJ's confidence in a return to sustained inflation, supported by a revival of wage growth, has paved the path to end negative interest rates after eight years.”
Experts disagreed about the impact of these moves. David Mitchinson, fund manager at Zennor Asset Management, described the end of negative rates as “an extremely significant event for Japan and world markets” whereas others saw it as a storm in a teacup.
Neil Wilson, chief market analyst at Finalto, said: “One swallow does not a summer make; and one interest rate rise by the Bank of Japan does not necessarily mean it is embarking on a hiking cycle. Less taking the plunge, more like dipping its dainty toes in the water.”
Chris Scicluna, head of research at Daiwa Capital Markets Europe, also played down the impact of the BoJ’s decision, describing it as “a baby step that should have minimal impact on the real economy”.
The market’s reaction has been muted because the changes were expected, Wilson said. “This had been terrifically well telegraphed in advance and the yen sold off on the news, dollar/yen jumping a full big figure to 150. I think that is what you may call a dovish hike.”
Naomi Fink, Nikko Asset Management’s global strategist, agreed. “The ‘trial balloons’ of media announcements in advance of today’s BoJ rate rise apparently did their job, as the end of negative interest rates, yield curve control and ETF purchases were smoothly digested by markets – indeed, the BoJ had already embraced greater flexibility on YCC and has significantly decreased its ETF purchases well prior to the policy decision. Neither the yen nor the Nikkei showed extraordinary movements, and JGB 10-year yields so far remain contained below 80 basis points.”
Yet although today’s news was not a surprise, Mitchinson thinks there could be significant implications for global capital market flows. “The US has been able to rely on large Japanese surplus savings to fund the deficit. With rates in Japan now rising and with elevated hedging costs this is increasingly unattractive. Will these flows reverse? What will the impact be on US rates?” Mitchinson asked.
Fink noted that “with the BoJ reluctant to signal further policy tightening, markets do not appear ready to give up on the ‘carry trade’ just yet – immediately after the decision, the yen remained under pressure, one sign that it is still being used to purchase higher-yielding overseas assets.”
Extrapolating these developments to asset allocation, the BlackRock Investment Institute is overweight Japanese equities and underweight Japanese government bonds.
Powell said: “We see the outlook for equities buoyed by healthy earnings momentum, accelerating shareholder-friendly reforms unfolding across Japan and valuation support from negative real interest rates. The sun is not setting on Japanese equities, in our view; it is merely rising on a new horizon.”
Fidelity International’s solutions and multi-asset business is also overweight Japanese equities. Asia economist Peiqian Liu said: “Economic surprises and earning revision are positive and business activities continue to recover in Japan. We maintain a neutral view on the yen because we see continued gradualist approach from the BoJ while the US Federal Reserve rate cuts are pushed out further down the horizon.”