Tightening BOJ, Loosening Government... Diverging Fiscal Policies in Japan

BOJ Hints at Possible Rate Hike
Clash with Japanese Government's Expansionary Policy
Weak Yen Drives Up Import Costs and Prices

"The government is stepping on the accelerator, while the Bank of Japan (BOJ) is taking its foot off," he said.

Reuters Yonhap News

On December 1 (local time), Marcel Thieliant, Head of Asia-Pacific at Capital Economics, made this statement to the Financial Times (FT), pointing out that the BOJ's increasingly hawkish stance is clashing with the Japanese government's expansionary fiscal policy. While the BOJ is considering raising interest rates due to concerns over the weak yen, rising import costs, and inflationary pressures, the government led by Sanae Takaichi is pushing for increased fiscal spending under the so-called "Sanaenomics." As worries mount over fiscal deterioration and a further weakening of the yen due to these policy discrepancies, BOJ Governor Kazuo Ueda has sought to reassure the market by hinting at the possibility of a policy rate hike this month.

According to the Nihon Keizai Shimbun (Nikkei), Governor Ueda stated during a speech at a financial and economic meeting held in Nagoya on December 1, "I would like to appropriately assess the timeliness of a policy rate hike at the upcoming monetary policy meeting scheduled for December 18-19." He also mentioned that corporate wage hikes are progressing smoothly and that he would gather additional information until this month's meeting. Effectively, this is the first time the possibility of a policy rate hike has been suggested since the launch of the Takaichi administration, which has advocated for aggressive fiscal policy. The BOJ raised its policy rate from 0.25% to 0.5% per annum in January this year and kept it unchanged through six meetings until October. If the rate is raised by another 0.25 percentage points this time, it will reach 0.75% per annum.

The reason the BOJ is moving in a hawkish direction, contrary to the expansionary fiscal stance of the Takaichi Cabinet, is the pressure from the weak yen. Governor Ueda believes that the depreciation of the yen could drive up import costs and overall prices, thereby increasing core inflation. Core inflation is a key indicator the BOJ uses to determine the timing of rate hikes. He stated, "It is possible that exchange rate fluctuations now have a greater impact on prices than in the past," adding, "This is because companies are more actively raising prices and wages." This marks a departure from the BOJ's previous position that "the impact of the weak yen is temporary."

Some analysts suggest that the government is now willing to tolerate a rate hike to defend the yen. Although Prime Minister Sanae Takaichi, who claims to be the successor to Abenomics, was previously negative about raising the policy rate, this stance has recently softened. After her first meeting with Governor Ueda, the prevailing interpretation is that the political establishment in Japan is no longer opposed to a rate hike. Reuters also reported, "It appears that political opposition was resolved when Prime Minister Takaichi met with Governor Kazuo (Ueda) on the 18th of last month." The assessment seems to reflect concerns that a weaker yen, by raising the cost of living for food and energy, could significantly increase household burdens and directly threaten the Takaichi Cabinet's approval ratings.

Following Governor Ueda's remarks, the probability of a rate hike in December surged. In the overnight index swap (OIS) market, the probability of a December rate hike rose from 60% to 75% on the day. The market interpreted Governor Ueda's comments as a de facto signal of an imminent rate increase.

The foreign exchange market also responded immediately. As of December 2 (Korea Standard Time), the yen-dollar exchange rate at one point fell to 155.61 yen per dollar (indicating a stronger yen). Last month, after the Takaichi Cabinet announced its expansionary fiscal policy, the yen-dollar rate had briefly exceeded 157 yen per dollar. However, following the BOJ's signal of a possible rate hike, the market saw increased yen buying and dollar selling, leading to a stronger yen. This is attributed to Governor Ueda's comments on a rate hike, which enhanced the appeal of Japanese assets and increased demand for the yen.

In the bond market, long-term interest rates jumped. The yield on 10-year Japanese government bonds, a key long-term rate indicator, rose to as high as 1.875% on the previous day, the highest level in 17 years since 2008. On the same day, the yield on 2-year government bonds, which is sensitive to policy rate changes, also rose above 1% per annum for the first time in 17 years, reaching as high as 1.02%.

Nikkei commented, "Whether the Japanese economy and financial markets can withstand further rate hikes is now being tested," adding, "The 10-year government bond auction scheduled for December 2 will be an important test."

This content was produced with the assistance of AI translation services.