Bank of Japan’s Policy Shift Ushers in a New Era for Investors

The Bank of Japan (BOJ) has bid farewell to its negative interest rate policy (NIRP), yield-curve control (YCC) and quantitative and qualitative easing (QQE), marking the end of an era of extraordinary monetary easing. This paves the way for a more normalized Japanese bond market, offering fresh opportunities for investors who have been wary of this space over the past decade.

Time has come to transition away from NIRP, YCC and QQE

The BOJ's shift from a complex and overly accommodative stance (combining NIRP, YCC and QQE) to a 0%–0.1% positive policy rate and a simpler approach was no surprise. The fundamentals were supportive, and the changes were well-telegraphed ahead of the BOJ's meeting.

Inflation expectations in Japan have been largely reanchored to more positive levels. The combination of global inflation induced by COVID-19 and a weak yen, exacerbated by central bank policy divergences, served as the catalyst Japan needed to break free from entrenched deflationary expectations and offered an opportunity for the BOJ to retire some of its more inflexible policy tools.

The BOJ's pre-meeting communications underscored its expectations that it would maintain an accommodative policy stance, including the continuation of government bond purchases. This cautious rate increase is strategically aimed at managing the potential uptick in bond yields without causing market disruption.

A new inflationary landscape for Japan

The BOJ’s 19 March policy changes, while largely anticipated, should have minimal immediate market impact. However, the medium- to long-term implications could be significant, as the potential scale of the BOJ’s policy changes may be more than the financial markets currently anticipate.

A key question is where Japan’s trend inflation rates will stabilize post-pandemic. Although Japanese inflation has shown signs of moderation, and further moderation is quite possible, we believe the country appears to have settled into a “1-point-something” percent inflation rate, if not 2%. This marks a significant departure from the near-zero percent trend of the past three decades.

This new baseline represents a structural shift in the labor market and corporate pricing behavior. The era of Abenomics (2012-2020) saw a temporary mitigation in the decline of the labor force due to an increase in participation rates, but further improvements are now constrained. The pandemic’s global inflationary impact, coupled with the yen’s depreciation, has been a major catalyst for significant shifts in inflation expectations and corporates’ price and wage-setting behavior. While the BOJ’s 2% inflation target remains elusive, given the country’s still inflexible labor system and low productivity, a reversion to zero percent inflation seems equally unlikely.