Overview
What happened
As expected, the Bank of Japan stood pat at its June meeting, making no changes to either the policy rate of -0.1 per cent or its yield curve control (YCC) policy of maintaining the 10-year government bond yield target within a 0.5 per cent range above or below zero.
At the press conference, new Governor Kazuo Ueda reaffirmed the BOJ’s commitment to continued easing until significant changes in inflation expectations emerge. This didn’t come as a surprise to markets, which have moved to price out any prospect of hikes this year over the last few months. He also highlighted the importance to see sustainable wage growth in the medium term to support a more profound shift away from the deflationary mindset. In addition, he voiced concerns over the yen’s weakness, although he refused to comment on specific yen levels.
Our interpretation
The BOJ has retained its dovish bias while its multi-month review of monetary policy is being carried out. The statement expressed a balanced outlook on Japan’s economy while cautioning that uncertainty in the inflation outlook remained high, in part due to variability of the external environment. The BOJ added that inflation expectations have been more or less unchanged despite recent price increases.
As a result of this latest meeting, we believe markets will price in a lower possibility of an imminent exit from YCC, although expectations of eventual changes to easing policies may gradually be priced in when inflation and wage dynamics see more fundamental changes. Given the reaffirmed easing bias, we expect the yen to stay weak, at least in the near term. The key focus for markets is when will the BOJ start to signal that it is confident enough that underlying inflation trends and wage growth are on a sustainable footing. The next Quarterly Outlook Report due in July will be important to watch for signals of the beginning of policy shifts.
Outlook
As supply-driven stresses ease, we believe inflationary pressures will also abate in the coming months, slowing back down toward the BOJ’s price stability target of 2 per cent. However, we do not expect Japan to fall back into deflation again; for example, we think the recent outcome of the annual Shunto wage negotiations indicates a more stable rise in inflation expectations going forward. If this scenario for prices in Japan’s domestic economy does indeed prevail, then pressure on the BOJ to begin some form of YCC exit will build. But we expect the bank to impose two additional tests that would need to be met before starting to exit YCC. The first requirement is greater visibility on the global growth outlook, in order to avoid a situation where YCC starts to fade in the midst of a global recession, and the second is greater confidence in financial stability risks, particularly as it pertains to small Japanese banks’ management of duration risk. Given our base case that a US recession will unfold later this year or by early 2024, the risk that Japan’s YCC exit gets pushed out into next year is real.
Beyond YCC, we think the BOJ is likely to maintain its negative interest rate policy until it believes that underlying inflation is robust and is unlikely to be negatively impacted by external shocks. To assess the true state of underlying inflation dynamics, we expect the BOJ to focus on measures of core CPI, wages, inflation expectations and, crucially in our view, the GDP deflator. Given the central bank’s focus on wages, we think it is unlikely that the BOJ would feel comfortable moving on interest rates until it has seen more data, including the outcome of next spring’s Shunto wage negotiations. If the scenarios we’ve outlined here hold, we expect the BOJ could start hiking interest rates in the second half of 2024.
Asset Allocation views
Fidelity Solutions & Multi Asset currently has a neutral view of Japanese equities. Earnings breadth remains relatively weak compared to other markets, although companies are generally cash-rich and sentiment is positive. We have moved from overweight to neutral in our view on the yen because we see plenty of further downside while the BOJ mulls changes to YCC.
-- With additional assistance from Mohd Tariq Azim
