The dovish shift by the Federal Reserve may provide some breathing room for the Bank of Japan to deal with the weakness of the Japanese yen, but the policy divergence between the two major central banks could complicate rate hikes. Federal Reserve Chairman Powell signaled a rate cut, while Bank of Japan Governor Kuroda stated that they will closely monitor market instability and will still raise rates if inflation meets targets. The yen rebounded after the speeches, causing turbulence in global financial markets. The Bank of Japan faces political pressure and challenges from the global economic environment, making the prospect of rate hikes uncertain
The dovish shift by the Federal Reserve may provide some breathing room for the Bank of Japan to suppress the weakening of the yen, but if the diverging policy paths of these two central banks unsettle the market, the Bank of Japan's efforts to raise interest rates may become more complicated.
At the annual economic symposium held in Jackson Hole, Wyoming, Federal Reserve Chairman Powell sent the strongest signal of a rate cut to date. He stated that the timing for policy adjustment has arrived due to rising risks in the labor market and no further room for weakness.
Just hours before these remarks were made, Bank of Japan Governor Kuroda stated in parliament that the Bank of Japan will closely monitor the impact of market instability, but if there is still a prospect for inflation to sustainably reach the 2% target, the Bank of Japan will continue to raise interest rates.
Following Kuroda's speech, the yen strengthened against the US dollar, and the gains widened after Powell's speech as the market focused on the prospect of narrowing the US-Japan interest rate differential. The rapid appreciation of the yen triggered a closing of popular arbitrage trades, leading to turmoil in global financial markets.
Derek Halpenny, Global Markets Research Director at Mitsubishi UFJ Financial Group, stated in a report to clients that Kuroda has shown almost no signs of changing views and plans after the financial market turmoil earlier this month, hence the emergence of yen buying is understandable.
The rebound of the yen brought relief to the Bank of Japan. The Bank of Japan has been under political pressure, with politicians demanding it to prevent the depreciation of the yen as rising costs of imported food and fuel would harm consumption.
As Japan goes against the global trend of interest rate cuts, the yen and the Japanese stock market face the risk of severe volatility, making the path of interest rate hikes by the Bank of Japan full of uncertainty.
After raising interest rates in July, the Bank of Japan experienced significant volatility in the market, prompting the Bank of Japan to act cautiously. Kuroda stated last Friday, "The domestic and international markets remain unstable, so we will remain highly vigilant about market developments."
With Prime Minister Fumio Kishida, who appointed Kuroda as the Governor of the Bank of Japan, set to step down in September and pass the baton to the winner of the ruling party leader election, domestic political factors have also made the path of interest rate hikes by the Bank of Japan more complicated.
While most major candidates to succeed Kishida support the Bank of Japan's plan for moderate interest rate hikes, it is still uncertain whether the new Prime Minister will support rate hikes if turbulent markets drag down corporate profits.
Former Bank of Japan board member Makoto Sakurai stated, "Due to so much uncertainty, the Bank of Japan may not be able to take bold actions." He said, "It may be difficult for the Bank of Japan to raise rates until the domestic political situation stabilizes."
The latest Reuters poll shows that most economists expect the Bank of Japan to raise interest rates again this year, but more believe that the rate hike is likely to occur in December rather than October.
The Bank of Japan unexpectedly raised interest rates in July, and Kuroda also signaled further rate hikes earlier this month, shocking the financial markets and forcing his deputy to make dovish assurances that no rate hikes will occur until market stability is achieved Two sources familiar with the Bank of Japan's thinking said that the key message conveyed by Governor Haruhiko Kuroda in his speech to parliament last Friday was that while the Bank of Japan is not in a hurry to raise interest rates, the market turmoil will not disrupt its long-term plan to continue pushing up borrowing costs.
Jeffrey Young, CEO of DeepMacro, a US financial technology company that uses artificial intelligence to analyze economic indicators and policymakers' comments, said that a big data analysis of the Bank of Japan's recent comments indicates that the Bank of Japan's stance on raising interest rates remains "very positive."
Referring to the possibility of the Bank of Japan raising interest rates again, he said, "Will there be another rate hike before the end of the year? Very likely. That's what the model suggests. If inflation and economic growth remain robust, and the Bank of Japan's comments continue to lean towards no issues with inflation and economic growth, then the only thing that can really stop them from raising rates is market turmoil."
However, some analysts are more cautious about the strength of the Japanese economy. While consumption rebounded in the second quarter, rising living costs have weighed on household confidence. A slowdown in the US economy could also drag on exports.
Keio University scholar Sayuri Shirai said, "Domestic demand is very weak. From an economic perspective, the Bank of Japan has almost no reason to raise interest rates."