On March 19, the Bank of Japan (BOJ) raised its interest rate paid to commercial banks’ deposits with the central bank for the first time since 2007.
On the surface, it was a baby step of a 0.1 percent move. With a hike to zero percent from -0.1 percent, however, the BOJ has finally lifted itself out of negative interest rates. At the same time, the BOJ has announced the termination of asset purchases of exchange-traded funds (ETFs) and real estate investment trusts (REITs), to be specific. The central bank has also scrapped the “yield curve control” that has fixed the long end of the curve at targeted levels, though the BOJ may still intervene in long-term interest rates to keep them from rising rapidly.
Kazuo Ueda was widely expected to take these actions when he became BOJ governor a year ago, and he did. Developments in the economy in recent years have helped him do it. The COVID-19 pandemic has reawakened long-dormant inflation in the global economy. The yen’s rapid fall as a result of the U.S. Federal Reserve’s (Fed’s) aggressive actions became an additional factor in rekindling inflation.
In response to the government’s call for higher wages and salary hikes, Corporate Japan has given workers what they requested for two springs in a row. This spring’s average wage hike of 5.2 percent is the highest since the outset of the 1990s. On the other hand, inflation has been running even higher until recently, driving real wage hikes into negative territory. Negative wage growth has caused considerable dissatisfaction among voters against the ruling Liberal Democratic Party.
A year ago, Corporate Japan had already responded to Prime Minister Fumio Kishida’s call for higher wages, with a 3.7 percent hike on average. Still, small and medium enterprises (SMEs) could not keep up with large corporations due largely to their thin profit margins and weak balance sheets. In 2024, however, there are signs that SMEs are following large ones. Otherwise, they couldn’t recruit and hold onto good people amid acute labor shortages.
From a broader perspective, the end of the age of negative interest rates is the first step in forcing the much-needed restructuring of the economy. Higher interest rates weed out weak companies that have been kept alive at extremely low rates. They would contribute to greater productivity in the economy since SMEs have been dragging down the overall economy’s productivity.
But can the BOJ really do it?
Aggressive tightening is prohibitive politically due to the pain it causes.
There has always been a question of how high the BOJ can go. Since the turn of the century, it has erred twice with a rate hike that later turned out to be a move that shouldn’t have been made. In the late 1990s, the central bank went into ultra-low interest rates in response to a banking crisis and a series of rolling recessions that came with it.
In 2000, the BOJ, under Governor Masaru Hayami, made the first move to reverse such a policy, believing the Japanese economy had regained its health. However, the U.S. economy slipped into recession on the burst of the late 20th-century tech bubble, forcing the BOJ to move back into ultra-low rates.
Then Governor Toshihiko Fukui even embarked on an experiment of negative interest rates that was truly creative by the standard of that time. After several years, Japan’s banking system was finally cleaned up, and the economy was growing again, in no small part because of the growing demand from China. The stock market responded to such favorable fundamentals. In 2007, Mr. Fukui exited his negative interest rate experiment, declaring a victory.
By that time, however, in a small corner of the U.S. financial markets, a mega-crisis was brewing on rising default rates of subprime mortgages. Then, what happened in the economy is already history. Fed Chairman Ben Bernanke, who advocated aggressive printing of money to keep the Japanese economy out of deflation, went into quantitative easing that far exceeded Mr. Fukui’s experiment. The Fed’s “insanely” aggressive easing made the BOJ look lukewarm, driving the yen higher against the dollar, thus exacerbating deflationary pressure on the Japanese economy.
Lessons from the Global Financial Crisis drove the BOJ, under Governor Haruhiko Kuroda, to emulate the Fed and flood the markets with liquidity.
By the end of Mr. Kuroda’s 10-year tenure, calls for getting out of negative and zero interest rates grew. Mr. Ueda duly delivered on this in March. Conversely, the Fed is widely expected to reduce interest rates after Chairman Jerome Powell’s aggressive responses to inflation have run their course. The U.S. economy may or may not be on the cusp of the next recession, while the market overwhelmingly expects a soft landing.
A problem stands in the way of the BOJ’s attempt to normalize the interest rate structure. It is the Japanese economy’s low body temperature. It is considerably lower than that of the United States. Japan’s temperature started rising from a much lower level than the United States, and it only rose slowly. By the time the Japanese economy felt that temperature had increased enough to allow a rate hike, it had already been heating up in the United States, and the Fed had made great efforts to keep it from overheating. The speed gap between the two economies always makes it tricky for the BOJ to move to a tighter monetary policy. The Fed’s next cycle is definitely down.
It remains to be seen if the BOJ is capable of delivering a series of rate hikes for normalization. This seems like an uphill battle. Even if the U.S. economy manages to soft-land, the BOJ might back off from higher rates in the face of some signs of an already cooling U.S. economy and the relatively dovish Fed.
