Japan abandons negative interest rate policy
The Bank of Japan (BoJ) took a major step by raising its key rate and abandoning the negative interest rate policy it was the last of the world's central banks to do so, citing a long-awaited improvement in the wage situation as the driving factor.
Having adopted negative rates in 2016 to support economic activity and boost inflation, which has long been sluggish in Japan, the institution's decision, expected by financial markets, marks a departure from its previous stance. The Bank of Japan has kept rates unchanged since 2007.
Economist Tom Kenny of ANZ Bank described the shift as a "new era" for the BOJ, which has pursued an ultra-accommodative monetary policy since 2013.
The BOJ recognizes the emergence of a "virtuous circle between wages and inflation" and will now set the short-term interest rate in a range of 0% to 0.1%, up from the previous range of -0.1% to 0%.
Despite this adjustment, the BOJ emphasized in its statement that accommodative financial conditions will continue for the foreseeable future.
However, this transition period is expected to be protracted as the BoJ forecasts that the 2% inflation target will not be reached until the end of the latest macroeconomic forecasting period, which covers 2025-2026.
Nevertheless, Mr. Kenney believes that the BOJ will need stronger evidence that inflation in Japan is indeed on a sustainable trajectory to reach the 2% target before considering further rate hikes.
Decisions, including the rate hike, were not unanimous among the nine members of the Monetary Policy Committee, highlighting internal divisions within the institution.
With the end of the negative rate policy, the Bank of Japan ends an experiment that has been globally unique since the end of a similar policy in Europe in 2022.
In addition, the BOJ has ended its control of the Japanese bond yield curve, which aimed to keep ten-year bond yields near 0%. This tool, which had been criticized for distorting the bond market, has become increasingly flexible since last year, and since October the BOJ has allowed ten-year bond yields to exceed a "benchmark" ceiling of 1%.
The Bank of Japan intends to continue buying Japanese government bonds
However, the Bank of Japan plans to continue buying Japanese government bonds (JGBs) "in roughly the same proportions as before" to maintain its ability to respond effectively in the event of a "rapid rise" in long-term yields.
In contrast, it will end its non-JGB asset purchase programs, including exchange-traded funds (ETFs) and Japanese real estate mutual funds (J-REITs), and "gradually reduce" purchases of corporate debt securities, phasing them out "over the course of a year or so."
Financial markets had largely anticipated this normalization process by the BOJ, especially after the preliminary results of Japan's annual wage negotiations last Friday, which marked the country's highest wage increase since 1991.
In recent months, the BOJ has openly stated that this event was the key factor it was waiting for to start taking significant action, nearly two years after it began tightening credit conditions in the U.S. and Europe due to inflationary pressures.
Inflation has been a concern in Japan since 2022 due to a surge in energy prices following Russia's invasion of Ukraine, which resulted in the Bank of Japan's 2% target being exceeded.
However, domestic demand and economic growth in Japan remain weak, posing challenges to keeping inflation at this level in the long term.
Tokyo Stock Exchange's leading index Nikkei reacted positively to the BOJ's soft stance and expected statements, rising about 0.32% after opening the session in negative territory.
Meanwhile, the yen depreciated against the dollar, hitting a two-week low of 150.27 yen compared to around 149.3 yen per dollar before the BOJ's statements.
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