Why is the hawkish signal from the Bank of Japan "ignored"?

A week after the rate hike, the Bank of Japan (BOJ) made an emergency "surrender", indicating that in the implementation of monetary policy, actual actions have a greater impact on market expectations than hawkish signals. The BOJ is facing demands to provide clearer guidance on the future interest rate path.

At the end of July, Japan raised short-term interest rates from 0-0.1% to 0.25%, marking the second rate hike this year since the BOJ ended its 8-year negative interest rate policy in March. This unexpected move triggered unwinding of global carry trades, which have been financed by ultra-low-cost yen funding for nearly a decade. Analysts believe that this action by the BOJ supported the hawkish signal.

However, subsequent market turmoil forced the BOJ to retreat and pledge not to raise rates again until market stability is ensured. It seems that the central bank's communication is most effective when its words align with its actions.

Communication Challenges for the BOJ

Analysts believe that the BOJ's actual rate hike actions truly convey its hawkish signal, highlighting the communication challenge faced by BOJ officials including Governor Haruhiko Kuroda.

Previously, the BOJ had stated that the triggers for its rate hikes were clear, and policy decisions were more data-driven, but the BOJ took action before clear signs of a consumer recovery appeared. Analysts stated:

"This leads us to believe that the BOJ's rate hike in July was driven by a desire to support the yen's sharp decline, rather than based on strong economic data."

Shigeto Nagai, head of Japan economics at Oxford Economics, said: "The fundamental problem with BOJ communication is that, despite many economic indicators being weak, it still needs to provide hawkish guidance to curb the yen's decline."

In contrast to the hawkish communication in July, BOJ Deputy Governor Masayoshi Amamiya assured the tense market this month that there would be no rate hikes in unstable market conditions.

However, with the market now returning to a certain degree of calm, Governor Kazuo Ueda reiterated last Friday that the BOJ will continue to raise rates to a neutral level, neither stimulating nor restricting the economy.

Actions Speak Louder Than Signals: BOJ Needs to Clearly Guide Interest Rate Path

The BOJ's experience aligns with a new study announced at this year's Federal Reserve Jackson Hole annual economic symposium, " Only when the Fed implements substantial rate hikes do the public and the market fully understand policymakers' determination to ensure inflation returns to the 2% target."

The research report points out that policy rate actions help enhance communication effectiveness and may even be necessary, especially when there is high uncertainty in the monetary policy framework:

" Timely policy rate responses to inflation are important for influencing current financial conditions and indicate policymakers' serious attitude towards future inflation news."

It is worth noting that although Japan's highest inflation rate peaked at 4.2% in January 2023, much lower than the Fed's peak of 7.1% in June 2022 when it began raising rates, Japan's inflation in July was 2.7%, exceeding the BOJ's 2% target for over two consecutive years, with widespread wage increases starting to push up service prices In its latest forecast made in July, the Bank of Japan expects core consumer inflation to remain near the target level over the year ending in March 2027. It also warned that a depreciation of the yen could exacerbate inflation risks, leading to the need for the central bank to gradually raise interest rates.

With inflation expectations stabilizing near the new level of close to 2%, International Monetary Fund Chief Economist Pierre-Olivier Gourinchas stated last Friday:

"In our view, there is room for further normalization of monetary policy in the future, with policy rates gradually increasing for a period of time."

To avoid market confusion, some analysts believe that the Bank of Japan needs a medium-term framework to more clearly guide its long-term interest rate path. While the Bank of Japan releases quarterly long-term growth and inflation forecasts, it lacks a Fed-style dot plot or policymakers' interest rate projections, as well as estimates of the neutral rate.

Ueda stated last Friday that there is currently not enough data to derive a credible estimate of Japan's neutral rate, but the Bank of Japan will continue to try.

Jeffrey Young, CEO of the U.S. research firm DeepMacro, pointed out:

"The main task of the Bank of Japan is to shift the market's focus away from the next meeting or next rate hike and more towards guiding the market's attention to the trend of medium-term interest rates."