- Bank of Japan’s experiences suggest raising rates and withdrawing QE is not easy, at least for long
- Central bank fighting to placate both bond and currency markets (but it may have to choose)
- Identity of new Bank of Japan Governor could be key next step
“The Magnificent Seven and A Fistful of Dollars are just two examples of famous films that draw on the work of legendary film director Akira Kurosawa, but it is not just in the world of cinema where the West can take inspiration, and learn, from Japan,” says AJ Bell investment director Russ Mould. “What is happening in Japan’s financial markets right now could have implications for investors, not to mention central bankers and monetary policy in London, Washington, Frankfurt and elsewhere, because the Bank of Japan (BoJ) is locked in a titanic struggle with Tokyo’s bond and currency markets.
“Unlike the US Federal Reserve, the European Central Bank and the Bank of England, the Bank of Japan is yet to raise interest rates and it is yet to officially try to sterilise Quantitative Easing and launch Quantitative Tightening, whereby its balance sheet starts to shrink.
“The Bank of Japan’s zero-interest-rate policy (ZIRP) dates back to 1999 and QE to 2001.
“Those dates could be a clue as to how hard Western central banks might find it to move away from them on a sustained basis.
Source: Bank of Japan, FRED – St. Louis Federal Reserve, Refinitiv data
“Right now, stock and bond markets now appear to be pricing in a slowdown in inflation, a peak in interest rates and a soft landing for the global economy, in the view that the US Federal Reserve, European Central Bank and Bank of England can deliver such a glorious hat-trick.
“That would be nirvana indeed. But the BoJ has consistently found it hard, if not impossible, to tighten monetary policy for long.
“In 2016 it even launched QQE, or Quantitative and Qualitative Easing, so it could bring in Yield Curve Control (YCC). Under YCC, the BoJ stated it would buy unlimited amounts of Japanese Government Bonds (JGBs) and therefore in effect print unlimited amounts of money, so it could bend Japan’s fixed-income markets to its will and hold the yield on the benchmark 10-year JGB below 0.25%.
“After six years of that, even Japan has begun to see the sort of inflation for which Japan has strived after decades of near-deflation in the wake of the debt-fuelled equity and property bubble that finally popped as the 1980s ended and the 1990s began. At 4.0%, inflation in Japan stands at 32-year high.
Source: Refinitiv data
“However, there has been a cost in the fight to stave off deflation (and not just the loss of purchasing power suffered by Japanese workers and consumers, although pay growth has at least started to pick up during the latest shuntō, or annual wage negotiations between unions and companies). The yen began to tank and in late 2022 hit its lowest level against the dollar since 1998, just as the bond market rebelled against the ongoing QQE and money printing.
Source: Refinitiv data
“Something had to give, and the BoJ blinked. It decided to support the yen, perhaps in the view that a collapse in its currency could import more inflation than it would like, especially given Japan’s reliance upon foreign supplies of crude oil for its energy. The BoJ raised its cap on the 10-year JGB yield to 0.50% from 0.25%, so it did not have to buy quite so many bonds and print so much money.
“But that did not ease the pressure for long. Yes, the yen rallied, but the yield on the 10-year JGB flew out to 0.50% in the blink of an eye. Bond vigilantes continue to test the BoJ’s commitment to defending that new line in the sand.
Source: Refinitiv data
“The BoJ’s balance sheet already exceeds 100% of GDP so the vigilantes may not give BoJ Governor Haruhiko Kuroda much rest, although he steps down at the end of his second, five-year term in early April.
“The quandary of how best to manage the currency, the national debt, the BoJ’s balance sheet and its JGB holdings may well fall to his successor, especially as Kuroda continues to dismiss out of hand any scope for an exit from ZIRP or QE, even if the fight to avoid deflation seems to be less of a worry.
“Prime Minister Fumio Kishida will make the appointment and he will be aware of the economic and political stakes as policymakers look to keep bond and currency markets at bay, using any tools they have to hand.
“Central bankers and PMs and presidents around the world will be watching and learning, too, and no doubt hoping the ending mirrors that of another cinematic classic from Kurosawa.
“The Magnificent Seven can trace its origins back to The Seven Samurai and A Fistful of Dollars to Yojimbo, but it is the fate of Kagemusha that Western policymakers will wish to avoid as they seek to keep their own currency and bond markets sweet.
“In Kagemusha, a castle siege is successfully fended off at the Battle of Nagashino with the help of new technology, in this case guns. The attackers are mown down in a hail of bullets. The shadow warrior protagonist, the kagemusha, is killed and his body eventually washed away down a river, a feeling which perhaps Liz Truss and Kwasi Kwarteng can understand after the gilt and foreign exchange market turmoil seen during their brief administration.”
