[Awakening Japan]③ Japan Pondering Monetary Policy, Eyes on Ueda's Words

Wage-Led Inflation Must Persist
Worried About Missing the Chance to Escape Deflation After 30 Years
10-Year Treasury Yield Enters 0.7% Range for the First Time in 10 Years

Amid a global tightening trend, Japan, which has been pursuing a 'solo low-interest rate' path, is drawing market attention as to when it will shift its monetary policy. Recent deepening yen weakness and prolonged inflationary pressures have led to analyses suggesting that tightening could occur sooner than expected. However, considering that real wages remain negative and the private sector is accustomed to low interest rates, many forecasts suggest that monetary easing will continue for the time being.

Market focus is on the Bank of Japan's (BOJ) monetary policy meeting scheduled for the 22nd. Although there is little room to change the easing policy at this meeting, given recent remarks by Governor Kazuo Ueda and the yen's weakness, there is a high possibility of signaling a preference for tightening. In an interview with Yomiuri Shimbun on the 9th, Governor Ueda said regarding the timing of ending the negative interest rate policy, "It is currently not a stage where a decision can be made," but added, "If we reach a stage where we can be confident in sustained inflation accompanied by wage increases, lifting the negative interest rate, a core part of large-scale monetary easing, could become one of several options," showing a shift from his previous stance of maintaining accommodative monetary policy.

Kazuo Ueda, Governor of the Bank of Japan, is holding a press conference at the Bank of Japan headquarters in Tokyo on July 16.
[Image source=Yonhap News]

According to major foreign media, on the 19th, Japan's Minister of Economy, Trade and Industry, Yasutoshi Nishimura, also mentioned monetary policy normalization. At a press conference following the Cabinet meeting, he said, "Monetary easing is a policy to buy time for Japan to pursue growth strategies and structural reforms and return to a growth path," adding, "Inflation is now accelerating, and considering the global situation, (monetary easing) will eventually end and normalize." These remarks during the trading session led to a rise in long-term interest rates.

The hawkish remarks from Governor Ueda on the 9th also shook the Tokyo bond market and continue to have an impact. After the BOJ effectively raised the upper limit of the 10-year government bond yield to about 1% in July, the 10-year Japanese government bond yield, which had remained around 0.6% until early this month, broke through the 0.7% level as of the 11th following the governor's remarks. This is the first time in about 10 years since 2013 that the 10-year yield has exceeded 0.7%, and it has remained above 0.7% since then.

Conditions in the real economy that could lead to normalization of Japan's monetary policy are gradually improving. Japan's consumer price index inflation rate has remained in the 3% range throughout this year, and the GDP deflator for the second quarter rose 3.5% year-on-year. However, the market judges that uncertainty remains high regarding sustainability. Kim Taekyung, head of the Asia-Pacific Economic Team at the Bank of Korea, diagnosed, "Next year, Japan needs to record a growth rate that supports a stable inflation rate of about 2%, but since domestic demand must underpin this as a prerequisite, uncertainty still exists." Professor Lee Changmin of the Department of Convergent Japanese Area Studies at Hankuk University of Foreign Studies said, "Looking at the recently announced second-quarter growth, it would be desirable if it were driven by private consumption and capital investment, but in fact, the effect of reduced imports was greater than that of exports."

Professor Lee pointed out, "Most of the previously high inflation was driven by cost increases," adding, "Real wages are still negative, which means wage increases have not kept pace with inflation." To confirm inflation driven by wages and demand, growth rates in the second half of the year must be observed, and for full-scale tightening to be possible, Japanese companies, which had been engaged in 'price destruction competition,' need to shift to an atmosphere where they can add value and engage in 'price increase competition.' As Governor Ueda said, "There is a non-zero possibility that sufficient information and data will be available by the end of the year," if data released in the first half of next year pointing to positive real wages by the end of this year emerges, it could lead to changes in monetary policy.

The rise in government bond costs is also a burden. Kim Seunghyun, senior researcher of the Japan and East Asia Team at the Korea Institute for International Economic Policy, said, "Currently, Japan's government debt exceeds 200% of GDP, and the Ministry of Finance projects that if long-term interest rates rise by 1 percentage point, government bond interest costs will increase by about 3.6 trillion yen (approximately 32 trillion won) or more in 2026," adding, "Time is needed to consider ways to reduce the burden on the government."

The shock to the private sector is also a factor increasing the BOJ's concerns. Professor Lee explained, "Japanese households and companies have lived in a world without interest rates for 30 years and have adapted, so the emergence of capital procurement costs could be a very significant shock to the private sector."

The 'hawkish pause' decision at the U.S. Federal Open Market Committee (FOMC) meeting held on the 20th (local time) also deepens the BOJ's dilemma. Professor Lee said, "The interest rate gap between the U.S. and Japan has already widened significantly, and with pressure for interest rate increases in Japan, the U.S. signaling prolonged tightening could force the BOJ, which was planning to watch economic indicators over time, to make a hurried decision." He added, "If overall economic indicators continue to improve and their sustainability becomes certain in the second half of the year, the BOJ is expected to follow a process of abolishing the negative interest rate and yield curve control (YCC) policies around next year."