What outlook for the BoJ’s monetary policy?

The 2.4% annualised slump in quarterly GDP in the first quarter of the year created quite a headwind to a positive full-year growth outcome in 2024. So, even though Q2 and Q3 GDP data have shown growth, it still looks as if 2024 will have seen no growth at all. While that sounds disappointing, we’d point not only to the fact that the growth trend has improved as the year has gone on but also to the increasing share of growth that’s being driven by the consumer sector. Consumer spending rose an annualised 3.6% in Q3 after a 2.6% rise in Q2. Prior to this, consumption spending had shrunk in each of the previous four quarters.

In the Standard Bank’s view, the importance of this observation is not just that the improving consumer trend has lifted growth; it is that the rise reflects the fact that higher wage awards are being spent. For a long time, Japanese consumers have had a deeply entrenched deflationary mindset. It meant that any boosts to disposable income, often through fiscal stimulus, rarely led to a notable rise in consumption.

Instead, income windfalls were saved, and the benefit to the overall economy was small. But, in the past year or so, policymakers have argued that this deflationary mindset has changed, and the rise in consumer spending that has followed much higher wage awards in the spring would seem to lend credibility to such calls. This is important because it gives the Bank of Japan a license to lift policy rates.

This normalisation is not just important for the sake of the economy but also for the better functioning of the bond market. The BoJ has managed to lift policy rates twice so far this year, taking the rate from -0.1% to 0.25%. But this process has to be managed carefully, as the bank found out when it last hiked rates at the end of July.

This rate hike upended the stock market, leading the Nikkei to fall by more than 12% in one day, and also caused a flurry of yen-funded carry-trade unwinding that sent the dollar/yen down from around 160 to 140 in the space of little more than a month. For a central bank that does not like FX volatility, the BoJ created its own worst nightmare and did so because the rate hike came as a shock to the market.

For rather than provide any sort of guidance about the imminent change in policy, the BoJ seemed to employ a tactic that it has used in the past, which is to ‘leak’ the pending outcome to the press just ahead of the meeting. The BoJ has subsequently recognised that its guidance leaves a lot to be desired – but whether it will change its ways is another matter. This issue takes on particular relevance next month as the Bank could lift rates again at its December 19th meeting. Perhaps fortunately, the clearing out of yen-funded carry trades in August suggests that the market will not be as sensitive to a December rate hike as it was in July.

Nonetheless, the BoJ needs to trade carefully. There is an argument for delaying the next hike in order to see how the land lies once Trump comes into power in the US, particularly bearing in mind his threat to lift tariffs. If the BoJ waits, it could push the next hike into next spring – but many analysts fear that this might be too long, and so we expect the Bank to lift the policy rate to 0.5% next month.

A rate hike from the BoJ next month will offer a sharp contrast to likely rate cuts from the Fed and ECB in the same month. While another yen-funded carry-trade rout like August seems very unlikely, this policy rate divergence could still lift the yen. In addition to this, there is potential safe-asset demand for the yen resulting from tensions in Ukraine and Trump’s impending inauguration in January 2025.

In short, a period of significant yen strength seems possible and, through next year, the Standard Bank certainly believes that dollar/yen can fall to around 130, with euro/yen down at 150. Should dollar/yen fail to follow this script and, instead, rise to over 160, the BoJ will initiate a protest via currency intervention. Such actions bought time in the past, but little more. A break with the yen’s long-term downtrend would have to come from other sources, such as BoJ monetary policy, not FX intervention.