"Weakening Economic Momentum in Japan... BOJ Likely to Shift to Wait-and-See Policy in Second Half"

The Bank of Japan (BOJ), which has maintained a monetary tightening stance, is now seen as likely to shift back to a wait-and-see approach after the second half of the year, according to recent analysis.

Jung Yongtaek, a researcher at IBK Investment & Securities, made this assessment in his report titled "Weakening Economic Momentum and the Gradually More Cautious BOJ" on May 30.

First, Jung pointed out that the recent surge in Japan's 20-year government bond yield to 2.54%, the highest since 2000, was "a result reflecting supply and demand, rather than structural changes in the Japanese economy." He added, "Japanese economic indicators are showing signs of re-entering a slowdown phase, rather than signaling an escape from long-term deflation."

The most direct cause of this sharp rise in ultra-long-term yields is seen as a deterioration in supply and demand, rather than economic fundamentals. This month, the auction results for Japan's 20-year government bonds were the weakest since August 2012. Jung explained, "The reason this supply-demand imbalance has become so pronounced is the BOJ's quantitative tightening, given that the BOJ holds half of all outstanding Japanese government bonds." He further explained, "The reason for citing supply-demand deterioration as the direct cause is that, while inflation indicators remain high, actual economic indicators are moving in a negative direction."

Jung also noted, "Japan's high inflation is mainly attributable to exogenous factors such as a high exchange rate and changes in supply chains, while endogenous consumption factors play only a minor role." He pointed out that, in fact, Japan's retail sales have sharply declined since the beginning of this year, which he attributed to the decrease in real income since the second half of last year.

He continued, "For this trend to improve, we would need to see signs of a turnaround in investment and corporate earnings. However, investment indicators are flat, and leading indicators for capital investment, such as machinery orders and capital goods shipments, are declining. Corporate earnings are also showing a stronger downward trend," he observed.

In addition, the weakening effect of the weak yen since the second half of last year is expected to further widen the decline going forward. With added uncertainty from the Donald Trump administration in the United States, market consensus on Japan's economic growth rate has recently been revised downward at a rapid pace.

Jung concluded that, as economic momentum weakens and uncertainty increases, the BOJ is likely to revert to a wait-and-see stance in its monetary policy after the second half of the year. He stated, "If economic momentum weakens and uncertainty rises, changes in the BOJ's monetary policy normalization are inevitable," and added, "The recent sharp rise in long-term interest rates has made markets more sensitive, which is likely to make the BOJ act even more cautiously."