Analysis: BOJ Indicates Action Over Hawkish Signals Matters More, By Reuters

By Leika Kihara

JACKSON HOLE, Wyoming – At the U.S. Federal Reserve’s annual Jackson Hole economic conference, academics and policymakers focused on how central banks can influence market perceptions regarding monetary policy. The Bank of Japan (BOJ) gained attention for its decision in July to raise interest rates for the second time.

After eight years of negative interest rates, the BOJ made a significant change in March when it ended this policy. In April, it began hinting at future rate hikes, contingent upon inflation trends aligning with its forecasts.

Initially, the markets overlooked these signals. However, that changed last month when the BOJ followed through on its rhetoric, unexpectedly increasing short-term rates to 0.25% from a range of 0-0.1%. This move initiated a global unwinding of carry trades that had relied on the ultra-cheap Japanese yen for nearly a decade.

The ensuing market volatility prompted the BOJ to reassure investors that additional hikes would be paused until stability returned. This situation illustrated that central bank communication can have a profound effect when it is backed by decisive action.

The BOJ’s experience was echoed in new research presented at the Jackson Hole conference, which examined how central banks can improve their communication strategies. The paper titled "Changing Perceptions and Post-Pandemic Monetary Policy" emphasized that substantial rate hikes by the Federal Reserve were crucial in conveying its commitment to achieving a 2% inflation target.

The authors noted, "Policy rate actions contribute to, and may even be necessary for, the effectiveness of communication, particularly during periods of high uncertainty regarding monetary policy frameworks." They highlighted the importance of timely policy responses to inflation not only in shaping financial conditions but also in signaling policymakers’ seriousness about addressing inflation.

Japan’s inflation peaked at 4.2% in January 2023, significantly lower than the U.S. rate of 7.1% that prompted aggressive rate hikes by the Fed in June 2022. As of July, Japan’s inflation was at 2.7%, maintaining levels above the BOJ’s target for over two years, and wage increases have begun to raise service prices.

In its July projections, the BOJ anticipated that core consumer inflation would align with its target through March 2027. However, it also noted that yen depreciation could intensify inflationary pressures, justifying continuous rate hikes.

IMF Chief Economist Pierre-Olivier Gourinchas stated, "We expect inflation expectations to remain stable around 2%, leading the BOJ to start normalizing policy rates." He emphasized that there is potential for gradual increases in policy rates moving forward.

Despite the BOJ asserting clarity in its criteria for rate adjustments and emphasizing data-driven decisions, the need for a rate hike to convey its hawkish stance underscored the communication challenges faced by Governor Kazuo Ueda and his team. Analysts criticized the timing of the BOJ’s hike, suggesting it was more about stabilizing the yen than robust economic indicators.

Shigeto Nagai, head of Japan economics at Oxford Economics, remarked, "The fundamental issue with the BOJ’s communication is that it needed to signal a hawkish stance to counteract yen depreciation, despite many economic indicators showing weakness."

In contrast to the hawkish stance taken in July, BOJ Deputy Governor Shinichi Uchida recently reassured markets that there would be no further hikes while volatility persisted. However, with some stability returning, Ueda reiterated the BOJ’s intention to raise rates to neutral levels that neither promote nor constrain economic growth.

To reduce market confusion, some analysts argue that the BOJ should implement a medium-term framework offering clearer guidance on its long-term rate trajectory. While the BOJ provides quarterly forecasts for growth and inflation, it lacks a Fed-like dot plot of policymakers’ rate projections or an estimate of the neutral rate.

Ueda acknowledged the difficulty in determining a credible estimate for Japan’s neutral rate but committed to ongoing efforts in this area. Analyst Jeffrey Young of DeepMacro stated, "The primary task for the BOJ is to shift the market’s focus from immediate meetings or rate hikes to a longer-term perspective on where rates are headed."