Why was the Bank of Japan (BOJ) seemingly in such a hurry to raise interest rates for only the second time in 17 years and to stress that more increases could be on the way? The reasons have real significance for currency, bond and stock markets.
All of these may be obscured, however, by the apparent unwinding of the technology and artificial intelligence boom on Wall Street and the impact on stock prices. The market will have little appetite for forensic investigations of the BOJ’s motives if the rout continues.
The popular narrative is that the BOJ voted to raise rates – when market expectations were for a September hike and despite dissenting voices on its policy board – due to fears of rising domestic prices on the back of a weak yen. But rising import prices have had limited effect on consumer prices, not least because corporate Japan assembles so much of its production in Asia nowadays.
Or it may have been that the central bank sensed a coming collapse in markets and wanted to slip in a rate hike while it still could. Or, it may have been that the BOJ, acting in concert with the government as it often does, took to heart US presidential candidate Donald Trump’s remarks about wanting to weaken the dollar, and felt it should help things on their way by pushing up the yen with rate hikes.
A more likely explanation, however, is that the traditionally conservative finance ministry is getting worried about how Japan can meet its pledge to double defence spending and boost other public expenditure in coming years in the face of continuing heavy outflows from Japanese government bonds. Hike rates now while others are cutting and keep funds at home in the government bond market may have been the imperative.
Stocks likely volatile
The BOJ’s rate hike to 0.25% on August 1 from 0.1% in March – when it was increased from zero – hardly sounds dramatic by the standards of other major economies. But the move, as well as hints of more increases to come, was enough to drive up the yen.
Likewise, the central bank’s decision to roughly halve its monthly purchases of Japanese government bonds (JGB) to around 3 trillion yen (US$20.5 billion) by the end of next year sent a clear signal of ongoing monetary tightening, which will likely reduce capital outflows into US and other bond and stock markets in coming weeks and months.
That trend will likely continue, attracting Japanese pension fund and other institutional investor capital flows back into the JGB market and lowering yields, allowing fiscal planners to sleep easier at night.
All good news perhaps for Japanese bond markets, but not for the Tokyo stock market where the benchmark Nikkei 225 average dived 5.8% on August 2 to 35,909.70, and then plunged a record 12.4% three days later. Although the index has since regained a lot of the lost ground, analysts see it as being vulnerable to much volatility over the near term.
Under Prime Minister Fumio Kishida, Japan has launched an all-out and largely successful campaign to popularise equity investment and attract huge household savings out of bank deposits and from under proverbial mattresses and into active investment. Rising interest rates and crumbling equity prices could reverse all that.
Significantly, the Financial Times reported that the Japanese equity sell-off was accelerated by heavily leveraged retail investors rushing to get out of a popular exchange-traded fund, the Nomura NF Nikkei 225 ETF, which closed 11.5% down on August 2. “It’s been a profit-taking frenzy,” one broker was quoted as saying in the report.
There may be worse to come.
