- The gradual and anticipated pace of QT indicates a cautious approach to balance sheet normalisation
- The earlier-than-expected rate hike suggests that the BOJ is placing greater emphasis...
- ... on the yen as a factor influencing inflation
- We are bringing forward the next rate hike to 1Q 2025, and now anticipate that...
- ...the BOJ will raise rates by 50bps per year, reaching a terminal level of 1.00% by March 2026
During today’s meeting, the Bank of Japan (BOJ) announced plans to reduce its monthly purchases of JGBs from JPY 6tn to JPY 3tn by March 2026, with a quarterly reduction of JPY 40bn. Meanwhile, the BOJ decided to raise the uncollateralized overnight call rate to 0.25%, up from the previous range of 0-0.1%.
In the quarterly economic outlook report, the BOJ revised its FY24 GDP growth forecast downward from 0.8% to 0.6%. The forecasts for FY25 and FY26 remain unchanged at 1.0%. The core CPI forecast for FY24 has been lowered from 2.8% to 2.5%, while the forecast for FY25 has been raised from 1.9% to 2.1%. The core-core CPI forecasts are unchanged at 1.9% for FY24 and FY25, and 2.1% for FY26.
Gentle QT
Today's decision marks the formal start of quantitative tightening (QT). The pace of QT is gradual and aligns with both our expectations and consensus forecasts. Currently, the BOJ is purchasing approximately JPY 6tn in JGBs per month. Prior to today’s meeting, the consensus anticipated that the BOJ would reduce JGB purchases by half over the next two years.
With this gradual pace of QT, the BOJ’s JGB holdings are projected to decrease by about 7% by March 2026, with its ownership ratio falling slightly below 50%. In terms of GDP, the BOJ’s JGB holdings are expected to drop to 90% by March 2026, down from nearly 100% at present.
Strategic rate hike
Today's rate hike decision was not entirely unexpected. Approximately 25% of economists surveyed by Bloomberg anticipated a rate increase at the July meeting. While our base case had forecasted a rate hike for October, we had also acknowledged a 40% probability of a 15bps increase at this meeting. The guidance on future rate hikes and the terminal rate remains somewhat unclear. The BOJ stated that it will continue to raise the policy rate and adjust the degree of monetary accommodation if the economic outlook and price projections from the July report are realized. At the press conference, Governor Ueda mentioned that future rate hikes will be data-dependent and a 0.5% rate is not considered a specific limit.
Current domestic wage, inflation, and consumption data do not strongly support rate hikes. After the recent Shunto, wage growth increased to 2% YoY, still falling short of the 3% level needed to sustain 2% inflation. Consumption activity remains stagnant, suggesting insufficient evidence for a positive feedback loop between wages and prices.
The earlier-than-expected rate hike indicates that the BOJ is now placing greater emphasis on the yen as a factor influencing inflation and inflation expectations. Given the boosting effect of yen depreciation on CPI with a 9-month lag, it is likely that both core CPI and core-core CPI will remain around 2% through the rest of this year and into the first half of 2025, aligning with the BOJ’s forecasts in its latest economic outlook report.
As a result, we are revising our policy rate forecast, bringing forward the anticipated next rate hike to 1Q 2025. We now project the BOJ will increase rates by 50bps per year, reaching a terminal level of 1.00% by March 2026. This projection is higher than the market-implied BOJ policy rate, which currently stands below 1.00% for the next three years.
Market Implications
JGBs: The initiation of QT by the BOJ will reduce its dominant role in the JGB market, allowing market forces to have a greater impact on the yield curve. Private sector investors may demand higher yields to compensate for inflation risks. However, the BOJ's gradual and predictable approach to QT, along with its commitment to increase JGB purchases if long-term interest rates rise too quickly, should help to mitigate bond market volatility.
JPY: The USD/JPY exchange rate has significantly diverged from interest rate differentials over the past four months. Today’s BOJ rate hike could lead to an upward adjustment in JPY interest rate pricing, potentially unwinding JPY carry trades and strengthening the yen. However, external factors such as FOMC decisions, the November US elections, and global tech stock performance will also be crucial to monitor in the coming months. Our FX strategists forecast USD/JPY to reach 150 by end-2024 and 139 by end-2025.
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Ma Tieying 馬鐵英, CFA
Senior Economist - Japan, South Korea, & Taiwan 經濟學家 - 日本, 南韓及台灣
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