Why Japan's Big Rate Hike Was A Resounding Dud

It was on Kuroda's watch that the BOJ cornered the bond and stock markets and earned the dubious honor of helming the only Group of Seven central bank to grow its balance sheet beyond the size of its $4.7 trillion economy.

Kuroda could have salvaged some credibility with global investors by plotting an exit. He demurred, passing the buck to successor Ueda in April 2023.

Ueda did the BOJ no favors by slow-walking its move toward some kind of exit. Several times in mid-to-late 2023, markets were primed for a historic BOJ pivot. Instead, Team Ueda made tiny tweaks to bond trading bands .

Even those baby steps were watered down in the days that followed by large, unscheduled bond purchases to signal that nothing fundamental had changed for BOJ policy. And that error is now being repeated.

Immediately following the March 19 rate move, the BOJ signaled that waves of liquidity will still be flowing.“Ueda's dovish comments after the meeting were enough to end any post-decision bullish sentiment in the Japanese currency,” says analyst Daniela Hathorn at trading platform Capital.

On March 27, policy board member Naoki Tamura, a noted hawk, said the“accommodative financial situation will continue.” Tamura did say that the BOJ would“slowly but surely normalize its monetary policy.”

But in“BOJ time,” this could mean five months or five years. Why then wouldn't currency traders continue to assume the BOJ is all bark and no bite?

History matters, of course. Take the earlier attempt at normalization in 2006 and 2007. At the time, the BOJ ended QE and hiked official rates twice. The recession that followed enraged the political establishment. The BOJ later backtracked, returning to zero and restoring QE.

It follows, then, that the BOJ's credibility in global markets is lacking. Now, the watch is on to see if Ueda's team has the mettle to stick with its tightening cycle even if things get dicey.

A big test is the conflicting currents complicating Japan's 2024, including weak Chinese demand.

Japan only barely avoided recession in late 2023. Gross domestic product (GDP) expanded just 0.4% year on year in the October-December period after contracting 3.3% between July and September. In January, household spending plunged
6.3%, the sharpest drop in 35 months.

Meanwhile, inflation pressures might intensify as unions score the biggest raise in 33 years. The 5.28% pay bump secured during this year's“shunto” negotiations comes amid drum-tight labor markets and waning productivity.

“This points to strong real wage growth in 2024,” says economist Carlos Casanova at Union Bancaire Privée. He notes that“average monthly real cash earnings remained negative in 2023, given high inflation levels.”

The BOJ, Cassanova says,“has been waiting for a 'virtuous cycle' to take hold. This is a process through which sustained, imported 'cost-push' inflation, fueled by Japanese yen depreciation , results in changes to corporate behavior, such as rising wages and higher price-setting behavior. In turn, that can boost domestic consumption and fuel endogenous 'demand-pull' inflation.”

Soft growth, in the context of China's downshift, might argue in favor of no BOJ rate hikes this year. By contrast, upward wage pressures and the weakest yen since 1990 might support accelerated rate hikes.

Add in a ruling Liberal Democratic Party on the ropes amid economic discontent and public anger over a series of political finance scandals. Prime Minister Fumio Kishida is struggling to keep his approval ratings from falling out of the 20s (he ended 2023 at
17%).

Though the BOJ is officially independent, it's historically not known for bucking the political establishment. With looser and looser policies, BOJ governor after governor enabled change-averse politicians. The BOJ's largess removed the urgency for Tokyo to reform the economy and increase competitiveness.

Decades of free money took the onus off corporate chieftains to restructure, innovate or increase productivity. The ginormous corporate welfare program that the BOJ continues to administer deadened Japan's animal spirits, making it harder to resurrect them as China moves upmarket.

Devising the monetary policy equivalent of a 12-step program to wean Japan off excess liquidity now falls to Ueda. Step away from QE too fast and the BOJ risks setting up another 2006-2007 episode. Move too gradually and the BOJ loses even more street cred with global traders.

As of now, BOJ watchers are unclear on where Ueda might be headed, causing them to parse every word from the governor's mouth and BOJ statements.

Economist Takeshi Yamaguchi at Morgan Stanley MUFG says“we need to pay attention to the expressions 'given the current outlook for economic activity and prices' and 'for the time being.' As Ueda implied” this“suggests that the future policy path would depend on developments in economic activity and prices as well as financial conditions from the perspective of sustainable and stable achievement of the 2% price stability target.”

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Others reckon markets will have a very long wait for BOJ policy normalization to play out.“Central banks often are compelled to make judgment calls before the desired evidence is in,” says Richard Katz, author of the new book
“The Contest for Japan's Economic Future.”

“Failure to decide is also a decision. But in the case of this BOJ move, there does not seem to be any such compulsion,” Katz says.“If, when March 2026 comes and both wages and inflation fall short of the BOJ's forecast, how will the BOJ explain its rush to tweak?”

A woman looks at shoes on sale at an outlet store in Tokyo's shopping district, Japan. Photo: Asia Times Files / Twitter Screengrab

Part of the problem is that Japan's 2024 fortunes depend even more on events in Beijing and Washington than in Tokyo. In a new report, the Economist Intelligence Unit doubts China can hit its 5% GDP growth target this year.

“Consumer sentiment will remain fragile but will continue to recover gradually, supported by a rise in fiscal spending and looser monetary policy,” EIU analysts argue.“Despite the government facing pressure to boost growth, EIU expects it to maintain a cautious approach towards tackling pressing issues such as property sector stress and local government debt, even if this dents market confidence.”

That will have feedback effects for Japan. So will the shifting calculus concerning US Fed rate cuts . Japanese officials entered 2024 convinced that Fed Chairman Jerome Powell's team would be easing several times this year. As US inflation remains stubbornly high, economists are fast scaling back those forecasts.

Viewed one way, Ueda's team may be happy that the long-awaited shift away from QE didn't panic world markets. But BOJ officials should be disturbed by the yawning gulf between reality and perception about March 19. Traders are expressing the disconnect with yen sell orders.

It means that, at the very least, the BOJ is perceived more as a paper tiger than a feared authority whose sounds register in global markets. To raise the volume, Ueda's team will have to act bigger and less predictably next time. This means the BOJ must step out of its comfort zone as rarely before.

Follow William Pesek on X, formerly Twitter, at @WilliamPesek