In brief
- The Bank of Japan raised its policy rate by 25bps to 0.50%, marking the highest level since 2008, as part of its efforts to address persistent inflationary pressures and normalize interest rates.
- Japan's economy is challenged by a cost-of-living crisis, driven by negative real yields, lagging wage growth, and higher taxation, which have weakened consumer sentiment and impacted government popularity.
- For JPY cash investors, yields are now positive across all tenors and instruments. As the market anticipates further BOJ rate hikes, investors may adopt a diversified approach amid global economic uncertainty and market volatility.
Introduction
At its Monetary Policy Meeting (MPM) on January 24, the Bank of Japan (BoJ) decided to increase its uncollateralized overnight call (time deposit) rate by 25bps to 0.50% (Fig 1). The rate hike was widely anticipated by the market, with only one board member dissenting. This brings Japan’s policy rate to a level last seen in 2008. Governor Ueda justified the decision by noting that Japan’s “economic activity and prices… were developing generally in line with the Bank’s outlook”, while forecasting that upward pressure on the Consumer Price Index (CPI) was expected to persist until mid-2025.
Fig 1: BOJ has hiked rates to a 17-year high; Treasury bill yields have increased sharply in anticipation of further hikes.
Source: Bloomberg and J.P. Morgan Asset Management; data as at 24 January 2025.
Cost of Living Pressures
The Bank of Japan ended its yield curve control and quantitative easing policies in 2024 as inflation began to rise. Improving economic growth and increasing inflation prompted the central bank to start normalizing interest rates with hikes in March and July 2024. However, deeply negative real yields, lagging wage growth and higher taxation have reduced consumers’ net incomes. Concurrently, the weaker yen and higher food prices have led to a decline in living standard and a cost-of-living crisis.
The government is focused on achieving above trend growth and higher taxation which it believes are necessary to support spending and avoid additional debt accumulation. However, weaker consumer sentiment has negatively impacted the government’s popularity, prompting a shift to encouraging higher wage growth. With no sign of inflation abating, criticism of the current administration has increased, suggesting additional political paralysis and instability.
The confluence of these factors has compelled the typically cautious BOJ to revise its inflation forecasts upwards and hike policy rates.
Fig 2: Japanese interest rates have increased over the past several months while curves are upward sloping
Source: Bloomberg and J.P. Morgan Asset Management; data as at 24 January 2025.
Outlook
Japan’s negative interest rate experiment, which began in 2016, has now been decisively concluded, with interest rates across all tenors and instruments now positive (Fig 2). In a press conference following the policy meeting, BOJ Governor Ueda noted that the upward pressure on the CPI is expected to persist. The market anticipates two additional rate hikes, one in July 2025 and another in 2026, with a terminal rate of 1.0%.
For JPY cash investors, the era of negative yields has ended. Positive yields and an upward sloping yield curve now offer potentially attractive returns. However, we continue to emphasize caution amid global economic uncertainty and market volatility – implying the need for a diversified approach across maturities and instruments to achieve an optimal risk adjusted return.