People walk in front of the Bank of Japan building, in Tokyo, on April 7.ANDRONIKI CHRISTODOULOU/Reuters
Recent weakness in consumption has emerged as a fresh source of concern for Bank of Japan policy-makers who are eyeing an exit from negative interest rates, three sources familiar with its thinking said, suggesting market expectations of an imminent rate hike may be over-blown.
The yen and Japanese bond yields have jumped on market expectations of an imminent policy change after BOJ Governor Kazuo Ueda said on Thursday the central bank will face an “even more challenging” situation in the year-end and next year.
But Ueda’s remark, which came in response to a lawmaker’s question on the challenges he has faced since becoming governor in April, was taken out of context by markets and was not meant to signal an imminent policy shift, the sources said on condition of anonymity as they were not authorized to speak publicly.
“There was no intention to signal anything about the timing of a policy change,” which remains up in the air, one of the sources said, a view echoed by two other sources.
To be sure, the BOJ has its eyes set on pulling short-term interest rates out of negative territory, with inflation running above its 2 per cent target for more than a year.
Rising prospects for sustained wage increases have also heightened the chance of Japan seeing inflation durably hit the target, and meet the prerequisite set by the BOJ to end years of ultra-easy policy.
BOJ Deputy Governor Ryozo Himino said on Wednesday an exit from ultra-loose policy, if done properly, will reap benefits for the economy, signalling that an end to decades of super-low interest rates may be nearing.
But the timing remains highly uncertain given Japan’s fragile economy. Some BOJ policy-makers are worried about recent signs of flagging consumption, as wages have yet to increase enough to offset the rising cost of living, the sources say.
Data on Friday showed Japan’s economy contracted more sharply than first estimated in the third quarter, by an annualized 2.9 per cent, as both consumer and business spending shrank. That suggests domestic demand is not strong enough to offset the drag from sluggish global demand for Japanese exports.
Household spending fell 2.5 per cent in October from a year earlier as inflation-adjusted real wages slumped 2.3 per cent on-year, the 19th straight month of declines, data showed.
“The weakness in consumption is a big concern because it could prod firms to start cutting prices again,” a second source said, referring to the risk of a resurgence in deflationary pressures that dogged the economy for years.
“If that happens, an early exit will be out the window.”
The BOJ’s current rosy projection is based on the assumption that wage increases will accelerate and give households more purchasing power, thereby allowing firms to keep raising prices.
“The BOJ’s message has been unwavering, which is that it will keep ultra-loose policy until this positive wage-inflation cycle kicks off,” a third source said.
The strength of Japan’s economy is particularly important as an end to negative rates will likely be followed by several more increases in short-term rates, they said.
The BOJ next meets for a rate review on Dec. 18-19, followed by a more important meeting on Jan. 22-23 where the board will produce fresh quarterly growth and price projections.
Key data that could sway the timing of a BOJ exit include the central bank’s “tankan” business sentiment survey due on Dec. 13, and its regional branch managers’ meeting set to be held in mid-January.
“It seems like the BoJ is paving the way to a gradual normalization and giving the market a signal that the time is approaching. However, since these comments were made outside of the BoJ meeting, any sudden major change of policy is not expected this month,” analysts at ING wrote in a research note, referring to the comments by Ueda and Himino.
“We believe Governor Ueda is unlikely to adjust policy without prior communication,” they said, predicting that the most likely timing of a rate hike will be in June next year.
For now, the BOJ will keep dropping subtle hints that an end to negative rates may be nearing but won’t signal much on the timing, the sources said.
“In the end, it will be a judgment call,” one of the sources said on the timing of an exit.