Bank of Japan Set to Delay Policy Rate Normalisation, Says QNB

Doha, February 03 (QNA) – Qatar National Bank (QNB) emphasized that the Bank of Japan (BoJ) will likely increase the policy interest rate of only 10 basis points to 0 percent for the next meeting in April, while the next decisions will be highly dependent on incoming data.

All in all, given the outlook of falling inflation and weak economic activity going forward, the BoJ will remain highly cautious in its next decisions due to projections of low inflation and weak economic activity in the future, according to QNB weekly commentary.

The commentary emphasized that there are compelling reasons for the BoJ to be more cautious, having experienced below-target inflation for decades and even suffered from years of deflation. By the end of 2023, there were growing expectations that the BoJ was getting ready to begin a gradual process of normalization of its monetary policy stance.

However, these expectations were once again revised, given the evolving macroeconomic outlook and the earthquake that hit Japan on New Years Day. In this article, we discuss the key factors that explain why the BoJ will continue to delay its monetary policy normalization process.

In stark contrast to its peers in other advanced economies, BoJ followed a different path of monetary policy and kept its negative short-term interest rate of -0.1 percent unchanged. This “ultra-loose” monetary stance, compared to the aggressive tightening by the Fed and the ECB, led to a depreciation of over 40 percent of the Japanese Yen (JPY) against the U.S. dollar at the point of maximum pressure in October 2022.

The sharp depreciation of the JPY added to the impact of global supply shocks caused by the pandemic to push Japanese consumer price inflation to a peak of 4.3 percent year-over-year in January 2023, a level that had not been reached in this country in over 3 decades, QNB commentary outlined.

Moreover, QNB pointed out that despite the high rates of inflation, BoJ still stands as a notable exception to the recent trend of interest rate tightening of other central banks in advanced economies.

QNB cited two key factors that explain why the BoJ will continue to delay its monetary policy normalization process. First, the sustained fall in inflation rates has reignited fears that Japan could return to a lasting scenario with inflation meaningfully below target. After reaching a peak of 4.3 percent at the beginning of 2023, inflation began to drop sharply as the impact of the Yen depreciation faded, reaching 2.6 percent in the latest data print for December last year.

Second, despite a substantial recovery from the low during the Covid-pandemic, overall demand remains below the long-run production capacity of the economy. The BoJ uses capital and labour data to construct the “output gap” statistic, which measures the level of demand relative to the production possibilities of the economy.

This measure is closely monitored by the BoJ, given that sustained negative output gaps warn of potential deflationary pressures. During the Covid-pandemic, the output gap collapsed to a low of -4.1 percent, foreseeing the drop in inflation to the negative territory.

After 14 consecutive quarters in the negative range, demand had still not fully recovered as of the latest release of Q3-2023, when it was still 0.4 percent below production capacity.

The earthquake that hit Japan on New Years Day added to concerns, amid leading indicators that point to further softening in economic activity.

Thus, the overall outlook for Japans economic growth remains bleak, giving the BoJ another argument for delaying a policy interest rate increase change. (QNA)