The Bank of Japan's "back-and-forth" moves trigger market turmoil, with future policy decisions expected to become more complex

According to the Zhitong Finance and Economics APP, after the unexpected rate hike by the Bank of Japan caused global market turmoil, the Bank of Japan successfully calmed investors' nerves by signaling stable rate hikes. However, this change in communication strategy may indicate the Bank of Japan's determination to gradually withdraw from decades of stimulus policies. If the Bank of Japan, scarred by past policy mistakes and reversals over the past 25 years, allows the market to dictate, the bank's ability to break free from what is considered excessive support for the Japanese economy—namely achieving monetary policy normalization—may be limited.

For months, the Bank of Japan has been hinting at further steady rate hikes. However, last week, the Bank of Japan unexpectedly raised interest rates and announced detailed plans to reduce its large-scale bond purchase program. The Bank of Japan raised the policy rate by 15 basis points to 0.15%-0.25%, contrary to market expectations of no change. The Bank of Japan also announced that it would reduce monthly bond purchases to 3 trillion yen by the first quarter of 2026, with a quarterly reduction of about 400 billion yen.

Furthermore, Bank of Japan Governor Haruhiko Kuroda once again adopted a hawkish stance at the press conference following the rate decision. Kuroda stated that if the price outlook materializes, the Bank of Japan will raise rates again. He also mentioned that 0.5% is not a specific upper limit for interest rates, stating, "There is still a lot of uncertainty about Japan's natural interest rate. What we can say is that short-term rates are still far below the level that might make people doubt whether we are close to a neutral level."

With the hawkish stance of the Bank of Japan, the yen surged and the Japanese stock market plummeted— the Nikkei 225 index recorded its largest single-day drop since 1987 on Monday. Coupled with concerns about a potential economic downturn in the United States, these factors triggered turmoil in global financial markets.

However, on Wednesday, Bank of Japan Deputy Governor Shinichi Uchida stated that policymakers would not raise the benchmark interest rate if financial markets were unstable. He noted that recent market trends were "extremely unstable," and the central bank needed to temporarily maintain loose monetary policy. He added that due to mild inflation, the Bank of Japan had the ability to wait for rate hikes.

Uchida's remarks helped stabilize market sentiment. But chaos resurfaced on Thursday as the minutes of the Bank of Japan's July meeting showed policymakers focusing on a series of rate hikes to prevent excessive inflation.

Takuya Kanda, an analyst at Gaitame.com Research Institute, stated, "The Bank of Japan raised interest rates because it doesn't like a weak yen. Now it seems to be hinting at pausing rate hikes because it doesn't like the stock market decline." "If the Bank of Japan is so market-focused in its policy-making, it may not be able to raise rates significantly."

Kazutaka Maeda, an economist at the Meiji Yasuda Research Institute, mentioned that while Uchida's remarks stabilized the market, his significant change in attitude also "ultimately amplified market volatility." He pointed out that such significant fluctuations caused by the Bank of Japan's communication were undesirable.

![31.png](https://img.zhitongcaijing.com/image/20240808/1723113150589636.png? SMBC Nikko Securities economist Yoshimasa Maruyama said: "The possibility of the Bank of Japan raising interest rates in the near future has disappeared. In fact, the likelihood of another rate hike this year has greatly diminished."

According to derivative trading, the probability of the Bank of Japan raising rates by 25 basis points before the December policy meeting is only around 30%, down from 60% a week ago. In addition, the two-year Japanese government bond yield, which briefly rose to 0.46% after the Bank of Japan raised rates last week, has recently fallen to 0.27%.

Critics argue that the Bank of Japan reacts to market trends rather than data when formulating policies. However, Shinichi Uchida insisted on Wednesday that the Bank of Japan focuses on the economy. He stated: "If market volatility changes our forecasts, risks, and views on the possibility of reaching our target prices, then market trends will influence our decisions." "It is clear that our goal is to achieve price stability, thereby promoting healthy economic development. We will focus on economic development when formulating policies."

A Sense of Déjà Vu

The Bank of Japan has experienced similar situations in the past. In August 2000, the Bank of Japan raised rates to 0.25%, but just two weeks later, the bursting of the dot-com bubble led to over two years of decline in the Nasdaq index, which hit Japan's export-dependent economy. Eight months later, the Bank of Japan changed course and introduced a new experiment - quantitative easing: injecting a large amount of yen into the market to support the economy and combat deflation. Several years later, the Bank of Japan raised rates twice in July 2006 and February 2007. However, a few months later, the subprime mortgage crisis erupted, triggering a global financial crisis.

In both cases, the Bank of Japan faced intense political criticism for hastily withdrawing stimulus policies. This time, few Japanese politicians are calling for the Bank of Japan to ease monetary policy. In the days leading up to the Bank of Japan's rate hike in July, Japanese Prime Minister Fumio Kishida stated that the normalization of the Bank of Japan's policy would support economic recovery. Shigeru Ishiba, the main candidate seeking to replace Fumio Kishida in the September Liberal Democratic Party leadership election, expressed support for the Bank of Japan's gradual rate hike plan.

Over the past two years, as the yen fell to a 38-year low and the possibility of pushing inflation above the Bank of Japan's 2% target increased, Japanese politicians changed their stance and no longer demanded the Bank of Japan to ease policy.

Some analysts suggest that if the Bank of Japan's hawkish stance is seen as succumbing to government pressure, it may pay a price. Former Bank of Japan official Nobuyasu Atago said: "Recent data all indicate weakness in the Japanese economy, so the Bank of Japan's strong stance on future rate hikes is illogical. Its communication with the market could have been better."

Complicating the Bank of Japan's task is the possibility that raising rates while the Federal Reserve may start cutting rates could exacerbate fluctuations in the USD/JPY exchange rate and damage Japanese corporate confidence. Former Bank of Japan board member Takahide Kiuchi pointed out that the Bank of Japan has always avoided taking actions opposite to the Federal Reserve's for fear of harming exports and causing market turmoil. He said: "This time, the Bank of Japan may be overly concerned about public and political anger over the excessive depreciation of the yen "It is precisely the timing of the Bank of Japan's exit from stimulus measures that makes it highly challenging from the outset."

Eiji Dohke, Chief Bond Strategist at Tokyo SBI Securities, said, "Since last week's policy meeting, the Bank of Japan has made significant changes to its policy stance." He said that if the financial markets calm down, the Bank of Japan may restart discussions on further rate hikes as early as December, but the reaction of the yen may complicate the Bank of Japan's policy decisions