Decoding the BoJ: what might Mr. Governor be thinking

On Friday, April 26th, as the Bank of Japan (BoJ) kept interest rates unchanged (0.0% - 0.1%), the yen reached a fresh 34-year-old low, going through to 158 level. This continues the pattern of what one can describe as “patience and minimal action” by BoJ under Governor Ueda since he took the helm of the central bank a year ago in March 2023.

Furthermore, non of rumours of an intervention in the currency market due to the yen’s weakness did not materialise for a year and half until the yen weakened to 160 (yet to be officially confirmed). In particular:

• The BoJ was the last central bank in developed countries to end its negative interest rate regime in March 2024, nearly 3 years after inflation started rising.
• It took the BoJ 1 year after Mr. Ueda’s ascension to the Governor chair to officially end the yield curve control (YCC), something that was considered near imminent and expected by the market at the end of his predecessor’s term.
• None of the speculation around intervention in currency markets, a strategy used many times in the past by the BoJ, materialized since he took control until the yen weakened by nearly 23% and reached the 160 level.

Why a surprise? Because, having been marred by decades of deflation, a bout of inflation might have been welcome news for Japan, as it offered the BoJ a window to exit the low rates/deflation spiral.

Looking back over the last year, one would wonder if the BoJ has been overly cautious and whether it might continue this inflationary cycle with rates remaining at zero.

More importantly, the question remains whether the BoJ will continue putting caution ahead of inflation, having been traumatised by what is now generally considered being the error of raising rates too early in the 1990s following the banking/real-sate crisis.

Without realizing it, we might have had the answer in front of us.

Like Mr Bernanke and Ms. Yellen, M. Ueda comes to the BoJ after long career in academia. Bernanke’s study and body of work on the Great Depression (in 1930) and the market crash of 1929, greatly influenced his handling of the Global Financial Crisis of 2008.

Could it be that Governor Ueda’s monetary policy decisions are a reflection and also influenced by views developed through his academic research? So, to test this theory, we decided to have a closer look at his publications (of which they are many), to find clues into his thinking and views.

Monetary Policy choices

In a 2007 paper(1), Mr. Ueda suggested that the approach “whereby the Bank of Japan would have kept the policy rate at lower levels, possibly at zero percent, until inflation starts to show an upward trend more clearly”. This would have been preferable to what the BoJ did, by adjusting “the policy interest rate gradually upward in response to a healthy real economy despite stagnant behavior in consumer prices”.

This is generally in line with the BoJ's recent discourse and potentially explains the BoJ’s patience in the face of the observed inflation. The “trauma” of what is perceived as past errors seems to drive Mr. Ueda to a cautious approach, whereby overshooting inflation is perceived as of lesser risk than re-falling into zero inflation. In our view, this approach might be overzealous, as the window of opportunity to get out of ZIRP (by raising rates) might close if global inflationary forces subside.

Currency intervention by the BoJ

In a working paper dated 2012 and updated in 2016(2), Mr. Ueda and his co-authors conducted an in-depth study of the interventions by the Japanese Ministry of Finance (MoF) in currency markets during the period extending from 1991 to 2015 to counter the appreciation of the yen. The paper’s conclusion is that the purchase of US dollars by the MoF (i.e. buying USDJPY in order to devalue the yen) resulted “in a decline in US dollar yields to bond markets in other currencies, thus easing global monetary conditions”. In fact, the MoF generally purchased US Treasuries with the US dollar it had amassed during interventions.

Admittedly, the situation facing the BoJ is the reverse (i.e. a weak yen, whereby the MoF would be selling USD). Assuming such intervention would have the reverse effects cited in the study, then it would contribute to a potential rise in long-term US and global yields.

Could it be that the BoJ, which has already stopped the YCC, is wary of the risk such an intervention poses to the long-term rates and has so far favored being patient and is “sitting out” the global rate cycle, hoping for a strengthening of the yen at the end of it?

Where to from here?

Let us also remember that Japan’s balance sheet is very leveraged, with a debt to GDP of over 260%, with the government holding over 40% of government debt. While the central bank's mandate is focusing on inflation and the economy, it can not be oblivious to the effects its policy could have on government debt service and potentially on national finances and financial policy.

At this juncture, a combination of Mr. Ueda’s school of thought and externalities, such as the effect of government debt, point strongly to a BoJ that would continue to be patient unless there is a noticeable uptick in inflation figures (in the 3.0% to 4.0% range).

BoJ’s threshold for any rate hike or regular or repeated currency interventions will likely depend on how much a weakening yen affects inflation going forward (via import prices affecting roughly 40% of the CPI basket).

Should US and global inflation remain sticky and the Fed adopt a less accommodative tone, then there is a viable and non-negligible risk for the yen to further weaken to a level not seen since the 1980s (in the 170 to 200 range).

[1] “Trying to Make Sense of the Bank of Japan's Monetary Policy since the Exit from Quantitative Easing”

[2] “Currency intervention and the global portfolio balance effect: Japanese lessons”