Bank of Japan's policy path filled with risks after global market turmoil

Bank of Japan Governor Kazuo Ueda’s path to policy normalization got a lot rockier after market ructions this week, leaving him facing multiple risks ahead.
 

When he took the helm at the BOJ in April of 2023, Ueda inherited a complex monetary framework that seemed almost impossible to exit. After more than a decade of unconventional monetary easing, the bank held more than half of the market for Japan’s government bonds. And yet, after ending the world’s last negative interest rate in March, Ueda appeared to be moving smoothly toward normalization.

Then markets erupted with volatility within days of a second hike on July 31. As many traders blamed the BOJ for sparking the global market gyrations by telegraphing further hikes, Deputy Governor Shinichi Uchida stepped in to assure investors the central bank won’t be raising rates when market instability persists.

 

The BOJ’s reaction to the turbulence may have compounded its challenges, according to Nobuyasu Atago, chief economist at Rakuten Securities Economic Research Institute. Uchida’s citing of market conditions as a policy factor broke away from the data-dependent approach the central bank has followed until now, he said.

“The BOJ has got it wrong,” said Atago, who is also a former BOJ official. “The language of monetary policy should be data.” 

The comments had the effect of clouding the bank’s policy priorities.

“While the main reason behind the crash this time was concerns over a US hard landing, the BOJ has created unnecessary noise,” said former BOJ official Masamichi Adachi, currently an economist at UBS Securities. “The policy decision itself was problematic but there were communication problems as well.”

The BOJ isn’t alone in facing communications challenges. Over the years, officials around the world have sometimes struggled with the reverberations from financial markets.

When Federal Reserve Chair Jerome Powell in December 2018 said a contraction of the US central bank’s bond portfolio was on “automatic pilot,” it helped set off a four-day slide in US stocks. The following month the Fed signaled it was abandoning further interest-rate hikes and would be flexible with reducing bond holdings. One of his predecessors, Ben Bernanke, in 2013 triggered a selloff in swathes of global financial markets after suggesting the Fed would before long start phasing out its quantitative easing, in an episode later dubbed the taper tantrum.

In some ways, investor complacency after such a long period of steady BOJ policy made the likelihood of jumpy markets inevitable when it came time for Japanese authorities to exit.

“This is the first full-scale rate hike in over 20 years,” said Tetsuya Inoue, Senior Chief Researcher at Nomura Research Institute and former secretary to Ueda when he was a board member two decades ago. “Of course it was going to be hard.”

Takahide Kiuchi, a former BOJ board member who consistently voted against record monetary easing under the previous BOJ governor, Haruhiko Kuroda, said that if anything, Ueda should have acted sooner with the second rate hike.

“The yen weakened and stocks rose too much,” said Kiuchi. Given the length of time that extraordinary easing went on, various positions have piled up in the financial markets, he added. “The more excessive a position, the more violent the adjustment afterward is likely to become,” he said.

Markets have yet to settle. While the Nikkei 225’s implied volatility has calmed after the index’s recent gains, it’s still about double the daily average this year through July 31, before the rout began. Investor uncertainty on the outlook for Japanese assets remains high, with one option market gauge of expected swings in the yen trading about 60% higher than its 10-year average on Friday.

The BOJ will need to see where the dust settles in the markets, according to Kazuo Momma, a former executive director in charge of monetary policy.

“It’s difficult to tell what the risk of failing normalization is right now,” said Momma. “One thing that can be said, though, is that it’ll probably take more time than previously thought.”

Leading up to the July decision, the central bank faced unusual political pressure. Two senior members of the ruling party weighed in on BOJ policy and the weaker yen, seemingly advocating for a hike that would buoy the currency.

Japan’s main opposition party has since criticized the BOJ for its rate-hike decision, with senior party member Jun Azumi saying Ueda will be called in to parliament soon.

“There’s no doubt that the BOJ’s decision to hike policy rates to 0.25% has become a major turning point for Japan’s monetary policy, leading to impact on stocks and currencies,” Azumi told reporters Monday. “It’s important to discuss in parliament what the BOJ will do going forward, and how the government views the environment Japan’s economy is placed in including the global economy.” 

A parliamentary committee will meet on Tuesday to decide when Ueda and Finance Minister Shunichi Suzuki will be called in for questioning.
 

“I feel sorry for Ueda, as the BOJ is being framed as one of the culprits” behind the market turmoil, said Tatsuo Yamasaki, a former chief currency official. “Everyone talks negatively about Ueda, but the rate-hike decision helped correct the yen’s weakness, which was a major concern.”

Another risk on the horizon is the ruling Liberal Democratic Party’s leadership election that’s slated for the fall. Depending on who gets the top job, the central bank could face fresh pressure in unexpected directions.

Ultimately, the BOJ needs to stick closely to data in its policy communications, Rakuten’s Atago.

Given that Ueda will have to continue to steer through concerns over the US economy, the central bank is in a difficult patch in terms of communication, he said. 

“The BOJ will have to be very careful.”
 

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