Analysis: Fed’s Dovish Shift a Mixed Blessing for BOJ Rate Hike Plan

By Leika Kihara

JACKSON HOLE, Wyoming – The U.S. Federal Reserve’s recent dovish approach may provide the Bank of Japan (BOJ) with some breathing room in its efforts to manage a weakening yen. However, this divergence in monetary policies could complicate the BOJ’s path toward raising interest rates, particularly if market volatility escalates.

During an annual symposium in Jackson Hole, Fed Chair Jerome Powell stated that "the time has come" to decrease rates due to increasing risks in the job market, which leaves little room for further economic weakness. This signals a likely policy easing in the near future.

Shortly thereafter, BOJ Governor Kazuo Ueda addressed parliament, indicating that while the BOJ will remain vigilant regarding market instability, it will proceed with rate increases if inflation remains on track to consistently meet its 2% target.

Following Ueda’s comments, the yen strengthened against the dollar, with markets reacting positively to the potential for a smaller interest rate gap between the U.S. and Japan.

Derek Halpenny, head of global markets research at MUFG, noted that Ueda’s remarks showed minimal indication of a shift in the BOJ’s outlook after recent financial turmoil, making the yen’s recovery understandable.

The yen’s rebound is a welcome development for the BOJ, which has faced political pressure as the currency’s decline negatively impacts consumption by raising the cost of imported food and fuel.

Nevertheless, the BOJ’s strategy to increase rates is fraught with uncertainty, particularly as Japan navigates against a global trend of rate cuts. This could make both the currency and stock prices vulnerable to significant fluctuations.

The BOJ is still feeling the effects of market disruption following its July rate hike, prompting a cautious approach moving forward. Ueda emphasized the importance of monitoring market developments, noting that substantial market fluctuations may influence policy decisions if they modify inflation outlooks.

Additionally, domestic political factors complicate the BOJ’s approach, as Prime Minister Fumio Kishida, who appointed Ueda, is expected to step down, leaving his successor to be determined in a leadership election set for September.

While most frontrunners vying to succeed Kishida support the BOJ’s moderate rate hike plan, it remains uncertain whether the new prime minister will endorse higher borrowing costs if volatile markets negatively affect corporate earnings.

Former BOJ board member Makoto Sakurai expressed skepticism about the central bank making bold moves amid uncertainty, suggesting there is little likelihood of another rate hike this year until the political landscape stabilizes.

A recent poll indicated that many economists anticipate the BOJ will implement another rate hike this year, with a preference for December over October as the timing.

The BOJ’s unexpected rate increase in July, coupled with Ueda’s hints at further hikes, initially unsettled financial markets, necessitating reassurances from his deputy that no hikes would occur until market conditions improve.

Ueda’s comments in parliament reiterated that while the BOJ is not in a hurry to raise rates, it remains committed to its longer-term goal of increasing borrowing costs, according to sources familiar with the situation.

Analyst Jeffrey Young noted that an analysis of recent BOJ communications supports its rate-hike stance, with a continued positive outlook on inflation. He suggested that if stable inflation and growth persist, the likelihood of further rate hikes could increase, barring market-related disruptions.

However, some analysts remain cautious about Japan’s economic resilience. While consumption showed signs of recovery in the second quarter, rising living costs have negatively impacted household sentiment, and a slowdown in the U.S. could further influence exports.

Sayuri Shirai, an academic at Keio University in Tokyo, commented, "Domestic demand is very weak. From an economic perspective, there’s little reason for the BOJ to raise rates."