(Bloomberg) — Bank of Japan Governor Kazuo Ueda raised interest rates to the highest level since 2008, avoiding market turmoil by carefully signaling his plans to investors. But that strategy carries its own risks.
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Ueda and his board hiked the overnight policy rate to 0.5% on Friday in a move that was almost entirely priced in by traders. The decision left little more than a shallow ripple in global markets, with the yen strengthening slightly against the dollar. Investors are preparing for more hikes to come and the prospect that Japanese rates may reach 1% or more by next year, or even sooner.
The relatively smooth reaction contrasts with the market mayhem that followed a far less telegraphed BOJ rate increase at the end of July. Ueda’s move then was blamed by some for triggering the biggest daily fall on record in Japan’s Nikkei 225 stock index and a confidence-sapping slump in markets around the world including US equities.
The heavy signaling for the January meeting may not always be desirable. Over time, this limits the ability of investors to make independent bets, distracts from the economic factors that should drive policy and reduces the central bankers flexibility to change course at the last moment.
“This much clear communication to have markets price in the rate hike could be dangerous if used too many times because markets will only look at what the BOJ says,” said Tetsuya Inoue, senior chief researcher at Nomura Research Institute and former BOJ official who was a secretary to Ueda when he was a board member more than two decades ago. “That will deteriorate the functioning of markets to reflect the state of the economy and views within the market.”
Friday’s well-flagged hike adds to Ueda’s track record of transforming BOJ policy from baffling experimental complexity to orthodox simplicity. The governor has managed to normalize the central bank’s approach at a speed few expected even at the BOJ when he took the helm from former Governor Haruhiko Kuroda in April 2023.
He has jettisoned the asset-buying programs and the manipulation of bond yields and has largely returned the BOJ to conventional rate setting. The turmoil of last summer is one of the few blemishes.
“The BOJ’s shift in communications suggests that it was a traumatic experience for them to see global markets destabilized after the July hike,” said Mari Iwashita, executive economist at Daiwa Securities.
The central bank appeared to steer markets toward the hike through a speech by Deputy Governor Ryozo Himino a week before the meeting on Jan. 14. For some observers it looked like a carefully scheduled set piece aimed at delivering a hint. And it did just that as Himino said the board would consider the need to raise interest rates at the January meeting.
His remarks left three-quarters of economists surveyed by Bloomberg expecting a rate hike in January. When Ueda himself followed up with a reiteration of the same phrasing the following day, the governor reinforced the idea that the top brass at the central bank were already aligned on the need to move.
Traders of overnight swaps went from seeing the likelihood of a move this month at around 34% on Jan. 10 to almost 99% by Jan. 17 after the two speeches and a report from Bloomberg flagging the likelihood of a rate hike.
‘Inflict Pain’
“Unlike the Federal Reserve or the European Central Bank, the BOJ is at the stage of raising rates and as rate hikes inflict pain on the economy, they require careful communication,” said Tomo Kinoshita, a global market strategist at Invesco Asset Management Japan Ltd. “I expect they will continue to communicate in a way that reduces the risk of hikes jolting global financial markets.”
The approach of signaling on the way up and surprising on the way down aligns with standard central bank practice. But for some economists the latest move was too completely priced in, begging the question of how explicitly the BOJ intends to signal its plans in the future.
The BOJ’s upgraded forecasts predicting at least 2% price growth across the board for its three-year projection period seemed aimed at showing the bank’s greater confidence in the stability of the inflation trend and its scope for raising interest rates further. The BOJ reiterated its view that it will continue to hike borrowing costs as long as its forecasts materialize.
“The market is already pricing in another 25 basis point hike in the second half of 2025,” said Alvin Tan, FX strategist at Royal Bank of Canada. “I think another 25 basis point rate hike would be my baseline scenario, but risks of a third hike this year is growing in my view.”
What Bloomberg Economics Says…
“We maintain our baseline scenario that the BOJ will deliver two more 25-basis-point increases this year — in April and July — taking its target rate up to 1.0%, the lower end of estimates of Japan’s neutral rate.”
— Taro Kimura, economist
For the full report, click here
During his post-decision briefing Ueda said there was no set course for rates and he played down the significance of Himino’s comments, in a possible sign he will refrain from hinting so heavily going forward. He read from a prepared note and tried to imply that the remarks merely spelled out the obvious process of each policy decision.
“Through Deputy Governor Himino’s speech in January we tried to give a reminder of our basic stance that at each policy meeting we properly look at the data available, and debate whether it’s appropriate to change monetary policy,” Ueda said.
Communication was one of the first few things Ueda pledged to work hard on when the news broke that he was going to be nominated as BOJ governor in February 2023. As an academic, it’s vital to explain in a way that’s easy to understand, he told reporters then.
After a remarkably smooth policy transition in his first year, the fallout from the July rate hike demonstrated the difficulty of achieving that intention on a regular basis. But making each decision too obvious risks placing too much attention on individual hints from the governor and his deputies and depriving markets of a chance to position for alternative outcomes.
“Too much signaling by the BOJ is not good as the market will not function properly,” said Ayako Fujita, chief Japan economist at JPMorgan Securities. “Markets are only viable when there are divergent views.”
