Rising Prices Test Bank of Japan’s Dovish Stance

November 18, 2022 14:15

Core inflation hit a 40-year high in Japan during the month of October, testing the Bank of Japan’s (BoJ) dovish stance on monetary policy.

To put Japan’s inflation history into context, the country’s economy often struggles with low inflation and deflation. Post-COVID, this economic trend has been turned upside down as it lurched from lows to highs. While rising inflation might be a distortion of Japan’s average experience, it’s nonetheless a reality.

Yet through all the inflationary storms, the BoJ has kept interest rate guidance unchanged and in negative territory at minus 0.1 percent. The central bank is monitoring external developments and is aware of inflationary pressures but believes it’s not the right time to hike interest rates in Japan. Instead, monetary policy makers have intervened in the currency markets to support the Yen.

Much depends on whether other major economies can get inflation under control by tightening monetary policy, thereby solving at least one of the BoJ’s problems. This might be a faint hope, though, because high prices are proving to be more stubborn than originally thought. In the US, inflation declined in October but rose in two of its main trading partners, the UK and the EU, exposing the US to higher import prices from those regions.

When and how might the BoJ raise interest rates?

The BoJ’s next meeting will be held December 19 and 20 when there could be more clues as to whether monetary tightening is on the way in 2023. What are the possible scenarios when and if the BoJ decides to hike interest rates? There might be a shift from minus 0.1 percent to 0 percent, a level last seen in 2016. This could support the Yen against other currencies and drive spending power, depending on the wider inflation situation.

It’s vital for traders and investors to closely monitor the BoJ’s signals as the drivers for the Yen could change overnight if inflation keeps spiking in November and December.

Ever since the Federal Reserve started a historic round of monetary tightening nine months ago, the US Dollar powered forward, pushing the JPY against the ropes. The Federal Reserve’s hawkish stance appears set to persist into 2023 after comments from Governor Waller, who said that one report does not make a trend.

“It is way too early to conclude that inflation is heading sustainably down...We’ve seen this movie before, so it is too early to know if it will have a different ending this time.” Federal Reserve Governor Christopher J. Waller (November 16 speech).

But what if US core inflation drops for a second month in a row? This could be the trigger for the Fed to moderate interest rate rises because of the lag between a hike and the effects on inflation.

“It takes months, and perhaps even longer, for the full effects of a rate increase to work through the economy.” Governor Waller.

Governor Waller said he would be more comfortable to consider a 0.5 percent hike given the improved inflation rate provided the November inflation report continues a declining trend.

“The federal funds rate can still be increased quite rapidly with several 50-basis-point increases...” Governor Waller.

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

Sarah Fenwick
Sarah Fenwick Financial Writer, Admirals London

Sarah Fenwick's background is in journalism and mass communications. She has worked as a correspondent covering Swiss Stock Exchange news and written about finance and economics for 15 years.