What’s happened?
The Bank of Japan (BOJ, the central bank) decided to keep its policy rate unchanged at 0.25% at its policy board meeting on September 20th, pausing after a 15-basis-point increase in July. On the same day, official data showed that headline consumer price inflation accelerated to a 10-month high of 3% in August, from 2.8% in July, following strong growth in prices for food and utilities.
Why does it matter?
The BOJ is determined to pursue monetary normalisation by raising interest rates and winding down its asset-purchase programmes. However, the pace of the policy shift and the terminal policy rate will depend on Japan’s economic fundamentals, notably the strength of private demand and inflation expectations. The pause in September was factored into EIU’s forecast, which anticipates that the next interest-rate rise, of 25 basis points, will be announced in December 2024.
Mindful of the negative impact of rising borrowing costs on private-sector demand, the BOJ is unlikely to raise its policy rate at consecutive policy board meetings. The pause in September was also facilitated by the decision earlier in the week by the Federal Reserve (the US central bank) to cut its policy rate by 50 basis points.
The deep slash in borrowing costs in the US will provide support for the Japanese currency, the yen, against the US dollar, thereby alleviating imported inflation in Japan. We expect the BOJ to maintain this cautious, gradual approach throughout its normalisation cycle, as it seeks to avoid soaring unemployment and stunted growth momentum.
The persistence of inflation and recent evidence of healthy wage growth have helped to set the stage for more interest-rate rises in Japan in the remainder of this year. The upswing in inflation in August resulted primarily from a surge in food prices (caused particularly by a shortage of the country’s staple food, rice) and utility bills (resulting from the planned withdrawal of government subsidies).
Consumer-facing utilities costs will moderate, as the government has announced a resumption of subsidies. By contrast, rice prices are likely to remain an underpinning inflationary factor in the coming quarters, owing to the Japanese government’s enduring policy of managing domestic production to shield rice farmers from price drops. Moreover, underlying inflation in Japan remains sticky, as a rise in core-core inflation (which strips out fresh food and energy prices) back above 2% in August demonstrated resilience in consumer demand.
What next?
The pace of interest-rate increases will depend largely on the strength and durability of wage growth and household spending, as the BOJ aims to cultivate a positive growth cycle driven by consumption in the private sector. We expect the central bank to sanction a 25-basis-point rate increase in December, followed by two more rate rises in 2025. We forecast that the terminal level of the policy rate in the current policy normalisation cycle will be 1%, which will be reached by the end of 2026.
The narrowing gap in borrowing costs between Japan and other major economies in the coming years will lead to a strengthening of the yen, which will lift the value of yen-denominated assets and reduce the profitability of the yen carry trade. However, risk is heavily skewed to the downside, as signs that rising interest rates were causing significant damage to consumer sentiment and household consumption would persuade the BOJ to slow monetary normalisation.
The analysis featured in this article can be found in EIU’s Country Analysis service. This integrated solution provides unmatched global insights covering the political and economic outlook for nearly 200 countries, enabling organisations to identify prospective opportunities and potential risks.