Kate Pusch

On Tuesday 31st October the Bank of Japan discarded a strict price ceiling on 10-year bond yields, one of the Bank’s monetary policies guarding against deflation. The policy change, a result of rising inflation, has instigated analyst discussion over whether or not the BOJ will finally tighten fiscal policy after nearly three decades of economic stagnation. 

Contextual Factors

In the wake of Japan’s economic bubble burst in the late 1980s, laxed monetary policy caused the Japanese Yen to dramatically decline against the US Dollar. If the Yen’s trade value (currently at 148.24) dips below 151.94, it will reach a 33-year low against the US dollar. While this has significantly increased export profits for many of Japan’s largest companies, executives have adopted an increasingly risk-averse attitude towards investing, causing  a large cash hoard to build up in Japan’s banks. Conversely, faced with higher import costs, corporations have been determined to keep other production costs down. Leniency with worker wage hikes, being one such example, has decreased Japanese purchasing power, driving down local demand and creating more stagnant economic conditions for smaller Japanese businesses to grow under.

Corporate reluctance to boost worker wages, despite mounting profits and the upward trend in inflation, presents a challenge for the BOJ who remains steadfast in its decision to withhold policy tightening measures until Japan achieves a stable 2% inflation rate. Although Japan’s inflation rate has surged notably in recent months, this is primarily due to external market shocks and the sustained devaluation of the Yen against the US Dollar. Meanwhile the absence of wage hikes has kept internal demand flat, if not on a decline. 

What Next?

As such, Japanese consumer demand is not the contributing factor to inflation the BOJ needs. The emergence of labour shortages resulting from Japan’s plateauing labour force, however, is putting pressure on companies to reconsider employee wages as an incentive strategy to attract and retain more employees. Such a change could kickstart a long-awaited price and wage growth cycle that would give the economy the boost it so desperately needs. 

More overall changes in policy will likely be indicated sooner by the BOJ’s updated inflation forecast – currently at 1.7% –that is to be published in January. Although it is unlikely the bank will follow up on its projections with action until April (when new wage negotiations are due to solidify), investors are still hopeful that it will indicate the BOJ’s direction for economic policy in the fiscal year 2024. 

Needless to say market watchers are holding their breath to see whether Japan seizes this chance to finally awaken from its long economic slumber.