The Bank of Japan is under pressure

In the wake of global inflationary pressure, all central banks, with rare exceptions, direct their monetary policy towards further tightening and a relentless fight against rising prices.

Olivier de Berranger
Olivier de Berranger, CIO

The US Federal Reserve (Fed), for example, just raised its rates by 0.75% for the second time in a row, a very rare move. Among these exceptions, we find the Bank of Japan, which, despite the beginning of inflation in its zone and a very low yen against the dollar, does not change course and maintains an over-expansive monetary policy. How to explain it?

Part of the reason is history. Japan suffered for thirty years a long period of stagnation and deflation caused by various crises that hit its economy after the double-headed speculative bubble burst in 1990 – the stock market and real estate. This unprecedented situation has prompted the Japanese central bank to respond with measures of the same magnitude, known as unconventional. First, by gradually reducing key rates to zero, and then by implementing the first asset buyback program, known as quantitative easing (QE), to inject liquidity. As a result, Japan was faced with sky-high public debt, amounting to 250% of GDP. This hard limit leaves very little wiggle room. Indeed, today the Japanese government cannot afford to incur high debt service costs. Consequently, the Bank of Japan is adopting a “Yield Curve Control” policy of actively buying government bonds to limit yields to a very low level.

The return of inflation to Japan today is far from worrisome, thanks to inflation levels that remain very moderate, below 3%, and wage growth being controlled. This event can even be seen as good news for the Bank of Japan as this is the configuration it has been looking for for years. Moreover, if we take a closer look at Japanese inflation, price fluctuations are mainly due to volatile exogenous parameters, namely energy prices and agricultural products. As the price pressures associated with global commodity demand begin to show signs of easing, this inflation could disappear within a few months or even a few quarters.

However, such inflation, which is essentially imported, cannot in all likelihood be considered healthy, since it is not the result of either strong growth or any domestic demand. Another alarming parameter is the Japanese currency. Indeed, the yen recently hit its lowest level in 24 years against the dollar. The situation is due to the gap, which continues to widen so far, between Japan’s monetary policy and that of the Fed. If the yen weakens further, it could lead to higher inflation, while slowing down the Japanese economy, which is struggling to catch up before the pandemic.

In short, the BOJ is faced with a major dilemma: maintain its yield curve control policy, hoping for lower inflation, or raise rates, risking hurting an already suffering economic performance. One thing is for sure: the archipelago’s central bank appears to be fully accepting this delay in reaction, as is the ECB. Doesn’t this herald a structural flaw in which the G7 central banks, more and more hostages of low interest rates, have fallen? The ECB still has zero rates with inflation at 8.6%. The Fed itself, having just raised rates to 2.50%, is starting to change tone, with inflation hovering at 9.1%. Can developed countries generally afford to raise rates in a sustainable but above all efficient way? The future will show us, but we may doubt it.

The information communicated is the result of internal research carried out by the management team as part of its UCI management activities and not financial analysis activities within the meaning of the rules.

This analysis is based on the best sources we have and publicly available information. They are in no way binding on La Financière de l’Echiquier and do not constitute investment advice.