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The BoJ and MoF appear to be at odds regarding further policy rate hikes. While the MoF sought the BoJ's exit from the negative interest rate policy to advance its goal of implementing a stringent fiscal policy, the prospect of additional rate hikes poses challenges for the government. Such hikes could dampen economic activity, potentially undermining the achievement of a primary balance surplus and necessitating supplementary budgets to support the economy. Additionally, rising interest rates would escalate the government's interest payments, further complicating fiscal sustainability. Despite achieving a primary balance surplus in the initial budget for FY25, maintaining fiscal surplus amid economic weakness becomes daunting with further policy rate hikes.
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In the April monetary policy meeting, while the BoJ expressed readiness for further rate hikes if inflation aligns with its outlook, the government remained cautious, emphasizing the need for coordinated policies to combat deflation. This cautious stance from the government may hinder the BoJ's intended trajectory of rate hikes. The BoJ, perceived as initiating the shift to austerity, might face blame for any economic downturn resulting from fiscal consolidation measures.
Private domestic demand remains below pre-Covid levels, suggesting insufficient momentum to counterbalance the impact of fiscal austerity. Consequently, market expectations lean towards Japan falling short of its inflation target, potentially deterring the BoJ from pursuing additional rate hikes.
Governor Ueda highlighted the challenge of determining a neutral policy rate, underscoring the importance of market consensus and discussion around this topic to stabilize the yen. The central bank's move away from the negative interest rate policy without clarity on neutral rates, coupled with weak domestic demand, contributes to the yen's persistent weakness despite the policy shift.
Looking ahead, the BoJ may contemplate raising its policy rate in late 2025, considering political uncertainties and the necessity of consensus-building on Japan's neutral policy rates. Given the government's reluctance towards further rate hikes, the BoJ may focus on managing yen depreciation by fostering expectations of future hikes. However, achieving consensus on neutral rates requires improving the functionality of the JGB market, potentially involving a reduction in the central bank's JGB purchases.
The MoF's inclination towards fiscal reforms may have limited the effectiveness of its FX interventions, as concerns over FX reserves' utilization for fiscal purposes linger. This hesitancy, combined with the BoJ's premature policy shift and lack of strong expectations for future rate hikes, likely accelerated yen depreciation despite tightening economic policies. Consequently, the debate over FX reserves' realized benefits could impede austerity measures outlined in the Basic Policies for Economic and Fiscal Management and Reform, allowing the continuation of the current government's "new capitalism" policy.
Insights Inspired by Credit Agricole (the BoJ): Credit to Their Analysis for Shaping Some Aspects of This Text.
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