Why Does the Bank of Japan Insist on ‘Low Interest Rates’? [Song Seungseop's Financial Light]

Bank of Japan to Maintain Short-Term Interest Rate at -0.1%
Contrary to Major Advanced Economies Raising Benchmark Rates Sharply
BOJ Governor: "Japan's Inflation Rate Is a Temporary Phenomenon"
Japanese Government Bonds Total 1,000 Trillion Yen; Interest Payments Will Rise if Rates Increase

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A staff member is organizing Japanese yen at the Hana Bank Counterfeit Response Center in Euljiro, Seoul. Photo by Mun Honam munonam@

[Asia Economy Reporter Song Seung-seop] To curb the steep inflation rate, major countries around the world, including the United States, are sharply raising their benchmark interest rates. The U.S. has raised its benchmark interest rate by 0.75 percentage points three times in a row, and the Bank of Korea also took two unprecedented big steps (0.50 percentage point hikes) in July and October. However, Japan remains unchanged. It still maintains a benchmark interest rate in the 0% range. Why is Japan the only country insisting on low interest rates?

The Bank of Japan (BOJ) held a monetary policy meeting on the 28th and announced that it will maintain the short-term interest rate at -0.1% and the long-term interest rate at 0±0.25%. It also decided to continue the policy of unlimited bond purchases to prevent long-term interest rates from rising above 0.25%. This means that the negative interest rate policy started during the Shinzo Abe administration in 2016 is still in effect.

BOJ Governor Says Inflation Rate Is Not Sufficient

Price-adjusted Shinbashi grilled meat restaurant Photo by Yonhap News

BOJ Governor Haruhiko Kuroda has cited ‘low inflation’ as the reason for not raising the benchmark interest rate. While other countries have to raise rates because their inflation rates are very high, Japan’s inflation rate is still not high. Governor Kuroda himself said earlier this year, “The environment is completely different between the U.S., where the consumer price inflation rate exceeds 8%, and Japan, where it is about 0.8%.” He set the ‘achievement of a stable 2% inflation rate’ as the criterion for when to raise the benchmark interest rate.

However, Japan’s inflation rate is on the rise. According to Japan’s Ministry of Internal Affairs and Communications, since April, the month-on-month consumer price index (excluding fresh food) has consistently stayed in the 2% range. Last month, it rose 3.0% compared to the previous month. This is the largest increase in 31 years and 1 month since August 1991 (3.0%), except for the consumption tax hike in 2014. Tokyo’s October inflation rose 3.4% year-on-year, marking the largest increase in over 40 years. It appears that Japan is exceeding the inflation rate mentioned by the BOJ.

However, the BOJ claims that the current inflation is ‘temporary.’ They argue that the rapid rise in prices of volatile items such as energy and food caused this. Governor Kuroda also said, “This is not a stable and sustained inflation accompanied by wage increases,” and “I think we can achieve the targeted 2% inflation rate stably next year.” This is interpreted as meaning they will not raise the benchmark interest rate immediately due to temporary inflation.

Japan’s Government Bond Balance Exceeds 1,000 Trillion Yen... Fear of Debt Prevents Rate Hikes

Former Japanese Prime Minister Shinzo Abe [Image source=Yonhap News]

However, experts point out structural problems in Japan’s economy. Because the debt is so large, raising interest rates would drastically increase the interest payments Japan must make. According to Japan’s Ministry of Finance, as of the end of last year, Japan’s government bond balance exceeds 1,000 trillion yen. This is an enormous amount, roughly 9,700 trillion Korean won. The national debt-to-GDP ratio is 256%, the highest among developed countries. If interest rates rise by 1 to 2 percentage points, the Japanese government would have to pay an additional 3.7 to 7.5 trillion yen annually in principal and interest. Even a 1% increase in interest rates would require spending 2.7% of GDP on interest payments. Since the benchmark interest rate is directly linked to fiscal burden, they cannot decide to raise it.

If the BOJ starts raising the benchmark interest rate now, it could send a risk signal to investors. Japan’s ultra-low interest rate policy has been maintained for nearly 10 years since former Prime Minister Abe. If they abandon this and raise the benchmark interest rate, it could signal that ‘the Japanese economy can no longer hold on.’ Foreign media sometimes call the BOJ’s cautious stance an ‘easy policy.’

Some analyze this as Japan’s stubbornness for economic growth. Since the 1990s, Japan has suffered from long-term low growth called the ‘Lost 30 Years.’ Keeping the benchmark interest rate low raises the exchange rate and improves price competitiveness in international markets, which helps export companies’ profits and economic growth. Last month, the Nikkei analyzed that the BOJ is persisting with monetary easing policies to boost economic growth shaken by the COVID-19 pandemic.

Yen Value Plummets Due to Ultra-Low Interest Rates... First Forex Intervention in 24 Years

Bank of Japan Headquarters
Photo by Yonhap News

Side effects are already being observed everywhere. The yen’s value has fallen excessively (exchange rate surge) is a representative example. At the beginning of this year, the yen was around 115 yen per dollar, but last month it soared to around 145 yen. In response, Japanese foreign exchange authorities intervened in the forex market for the first time in 24 years by selling dollars. On the 20th, the yen broke through 150 yen for the first time in 32 years and 2 months. It is estimated that they took exchange rate stabilization measures through ‘masked intervention,’ officially not acknowledging the forex market intervention.

If the benchmark interest rate is not raised, the exchange rate could surge again. To stabilize the exchange rate, Japanese foreign exchange authorities must continue selling dollars and buying yen. Currently, Japanese media estimate the scale of market intervention at 9.3 trillion yen (about 90 trillion won). Experts worry that since the U.S. will continue raising benchmark interest rates for the time being, even with Japan’s foreign exchange reserves reaching 180 trillion yen (about 1,750 trillion won), there will be limits to maintaining the exchange rate.

Haruhiko Kuroda, Governor of the Bank of Japan

If the exchange rate rise is not controlled, prices in Japan could rise further. If prices of oil, food ingredients, and various imported goods increase, citizens will have to pay more to live. If wages do not rise as much as inflation, real income decreases, and Japanese citizens will have to watch their purchasing power disappear quietly.

Nevertheless, the dominant view is that the BOJ will maintain its ultra-low interest rate policy for the time being. On the 28th, BOJ Governor Kuroda announced, “We will continue monetary easing until the necessary time,” and “If necessary, we will not hesitate to prepare additional monetary easing measures.”