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By Alexander JonesInternational Banker
On October 31, the Bank of Japan (BoJ) announced its decision to maintain its key policy rate at the ultra-low level of 0.25 percent, which was still its highest level since 2008. This move surprised very few. Rates were hiked in March for the first time in 17 years, ending eight straight years of negative interest rates, as well as in July from 0 percent to 0.25 percent, but the BoJ saw enough signs that inflation was converging towards its official 2-percent inflation target to pause. However, with renewed weakness in its currency, potential economic uncertainty stemming from Japan’s recent snap election and the rising threat of accelerating prices, further rate hikes could transpire before the end of 2024 to prevent Japan’s economic recovery from overheating, as well as to expedite policy normalisation.
“Looking at domestic data, wages and prices are moving in line with our forecasts. As for downside risks to the US and overseas economies, we’re seeing clouds clear a bit,” Governor Kazuo Ueda remarked at a press conference, suggesting that a more upbeat outlook for the US economy could spur the central bank to lift rates again at upcoming rate-setting meetings. That said, the BoJ also seemingly refrained from rocking the boat too much just prior to the US presidential election on November 5.
Prior to the rate announcement, Ueda seemed to adopt a more dovish tone, suggesting that the BOJ could “afford to spend time” weighing up the implications of risks such as US economic uncertainty and volatile financial markets. But with more upbeat economic data coming out of the United States in recent weeks, Ueda has dialled back his comments recently. “When we use language that we can ‘afford to spend time’ gauging risks, weak U.S. jobs data led to volatile market moves, which we saw as having a grave impact on Japan’s economy,” the BoJ governor acknowledged following the October 31 rate announcement. “Since then, we have seen some fairly good US data.”
In the October edition of its “World Economic Outlook” (WEO) report, the International Monetary Fund (IMF) predicted that Japan’s gross domestic product (GDP) growth would cool sharply to just 0.3 percent this year from 1.7 percent in 2023. This forecast is a hefty 0.4 percent lower than the previous one the IMF issued in its July WEO edition and 0.6 percent lower than its April forecast, which it attributed to a temporary supply disruption in the car industry and the base effect of historical data revisions. “Growth is expected to decelerate in Japan in 2024, with the slowdown reflecting temporary supply disruptions and fading of one-off factors that boosted activity in 2023, such as the surge in tourism,” the IMF also observed.
Strongly rising prices over the last couple of years partly explain this situation. Indeed, a Reuters poll published in early November showed a dramatic slowdown in Japan’s GDP growth for the third quarter to an annualised 0.7 percent, from the 2.9 percent posted in the second quarter, with the news publication citing analysts’ expectations of “persistently elevated prices” offsetting wage increases as a key factor, spurring a growing cost-of-living problem for policymakers to deal with. “The recovery is still halfway,” analysts at SMBC Nikko Securities wrote in an analyst report.
In a dramatic turnaround for Japan’s long-time deflationary economy from the 1990s onwards, accelerating prices now represent one of the biggest headwinds for the country’s ongoing economic outlook. July and August saw the annual inflation rate reach 2.8 percent and 3 percent, respectively, before cooling to 2.5 percent in September. As such, a Reuters survey of 505 major nonfinancial companies (NFCs) from October 23 through November 1 found that a “persistently high rate of inflation” underpinned manufacturers’ declining confidence regarding business conditions in November versus October. “Although there is demand, material prices are gradually rising, putting pressure on profit,” a manager at a non-ferrous metal firm explained.
Nonetheless, the IMF indicated it did expect Japan’s economy to stage a modest uptick in growth of 1.1 percent in 2025 due to stronger real-wage growth, which will drive private consumption. Deloitte also specified stronger wage growth as instrumental to the improved consumer outlook, with June 2024 marking the first time that nominal wages outpaced inflation since 2022. “Japan’s engine of economic growth is already switching from exports to consumer spending,” Deloitte noted in its “Japan economic outlook, October 2024” published on October 18. “A rapid rise in wages has finally given households the purchasing power they need to spend more.”
Wages did cool by late summer, with flat growth recorded for August. “Part of the problem for workers is that much of their wage growth was driven by bonus pay, which typically falls off after the summer,” Deloitte also stated. “Contractual wages, which exclude bonus payments, accelerated to 3% from a year earlier in August in nominal terms, which was the same as headline inflation. Nominal wage growth has accelerated, but the unemployment rate has trended higher this year.”
Oxford Economics predicted that improvements in real wages would lift consumption going forward, albeit with gains achieved at a “moderate pace”. Nonetheless, the UK economics-advisory firm expected the BoJ to proceed with policy normalisation “as long as consumption remains resilient and avoids a sharp deterioration”. The IMF also forecasted that the policy rate would rise further over the medium term towards a neutral setting of about 1.5 percent, which would be “consistent with keeping inflation and inflation expectations anchored at the Bank of Japan’s 2 percent target”.
“If we see wages rise at around the same level of this year, that would be a positive development for us,” Governor Ueda said when asked about prospects for wage talks between Japanese firms and unions next year. “But that alone won’t directly lead to rate hikes.”
The BoJ has forecasted the annual rate of increase in the consumer price index (CPI, all items less fresh food) at around 2.5 percent for fiscal 2024 (April 1, 2024, to March 31, 2025) before declining to around 2 percent for fiscal 2025 and 2026. The IMF similarly predicted inflation at 2.2 percent for the full calendar year 2024 before easing to 2.0 percent in 2025 as a long-term neutral rate, with the same inflation rate posted in its 2029 projections.
While the transmission mechanism of cost increases borne by Japanese firms from higher import prices being passed on in higher consumer prices is expected to wane, the BoJ stated that it expected underlying CPI inflation to increase “gradually”, according to its latest “Outlook for Economic Activity and Prices” report published on October 18, “since it is projected that the output gap will improve and that medium-to-long-term inflation expectations will rise with a virtuous cycle between wages and prices continuing to intensify”. Through fiscal 2025, the BoJ predicted that the impacts of the government’s measures to stem inflation would dissipate, which should also support higher inflation. However, declining prices in crude oil and other resources could somewhat offset this.
The surprising results of Japan’s snap general election on October 27 could add uncertainty to the country’s economic outlook. Taking just 215 seats, 17 seats less than the minimum requirement, the ruling Liberal Democratic Party (LDP) and its coalition partner, Komeito (NKP), lost their parliamentary majority, as the oppositional Constitutional Democratic Party (CDP) made sizeable gains. While concerns have been raised that an impasse over policy may arise from the new political reality, Governor Ueda confirmed that recent developments will not impact the BoJ’s price forecasts. “But if there are big changes in policy, we will revise our forecasts as needed, taking into account the impact of such moves.”
Despite the potentially impactful political situation, Oxford Economics has maintained its pre-election initial growth forecasts “because the LDP and opposition parties both support a wage-driven growth strategy and generous support for households suffering from high inflation”. Oxford Economics stated that with the ruling parties’ political bases having weakened as a result of the election, “the government will likely focus more on measures to sustain short-term demand without tackling painful structural issues”.
As for forthcoming monetary policy, the BoJ has remained non-committal over its plans, with Ueda admitting the central bank has “no preset idea” regarding the timing of the next rate hike. “We will scrutinise [the] data available at the time of each policy meeting and update our view on the economy and outlook in deciding policy.”
The Japanese yen’s renewed weakness since early October could force the BoJ’s hand in lifting rates sooner than planned. The central bank’s next monetary policy meeting is scheduled for December 18-19, followed by another one on January 23-24. With a weakening currency hurting consumers through higher domestic prices for imports, inflationary effects are being amplified throughout the Japanese economy. A tight labour market could also prompt further monetary tightening before the end of this year, with the IMF forecasting unemployment at 2.5 percent this year and next.
“Ueda’s remarks sounded somewhat hawkish,” said Hiroshi Watanabe, senior economist at Sony Financial Group. “Many market players had bet that the next rate hike will come in the January-March quarter next year. But he sounded as if he left open the chance of a December hike.” According to Deloitte, inflation is likely to remain elevated in the near term, which will keep the pace of spending modest. “A more hawkish monetary policy stance in the United States as well as a reversal of wage gains are risks that could further hinder Japan’s nascent recovery.”