Stéphane Monier, chief investment officer at Swiss private bank Lombard Odier, and portfolio managers Iain Cunningham and Alex Holroyd-Jones at Ninety One, an investment manager, discuss Japan’s economic prospects and the road ahead for its monetary policy.
Japan’s economy looks relatively healthy, giving the Bank of Japan an opportunity to wind down its yield curve control policy - in place since 2016, Stéphane Monier, chief investment officer at Lombard Odier, has said.
“With improving economic prospects that may outpace growth in the US and Europe in 2023, Japan is on a slow path to monetary policy normalization. Still, the BoJ has surprised markets as an outgoing governor navigates a path to change a more than six-year old strategy,” Monier said.
“Japan’s economy is looking relatively healthy. It has been less affected than Europe and the US by inflation, the war in Ukraine and energy market volatility. Its biggest export market, China, is reopening, promising a further boost,” he said in a note. “We expect the country’s gross domestic product to expand by 1.6 per cent over 2023, with average consumer inflation reaching 2.5 per cent, on the back of significant hikes to electricity tariffs. This is some way above market consensus estimates, and the central bank’s target for the second year running."
However, Monier believes that Japan’s economic growth is driven largely by consumer demand, so much depends on wages keeping pace with inflation, which by Japanese standards is exceptionally high. Two decades of low earnings' growth has made workers sensitive to rising prices. The annual round of industrial wage negotiations that start in February/March, known as ‘shunto,’ will therefore be closely watched.
“Japan’s largest federation of trade unions asked for a 5 per cent rise in total pay in November but its initial demands are usually watered down,” he said. “Meanwhile, Japanese fashion brand Uniqlo said it would raise wages by an average of 15 per cent from March. A 3 per cent wage increase – the highest for some years – would bring salary growth to the level that the BoJ said in 2022 would be sufficient to generate a moderate and sustainable level of inflation. The first batch of the negotiation results will be released in March and provide the first clue on how workers’ pay will behave this year,” he continued.
Japan has flattered to deceive investors over recent decades - with several "false dawns" since its economy slumped after a real estate crash in the late 1980s. An aging population and associated desire to hold cash and similar assets has weighed on the economy. However, in recent years a variety of forces, such as corporate governance reforms, have encouraged international investors to give the country a fresh look. (See, for example, this commentary over a year ago from Matthews Asia, a business that is headquartered in San Francisco.)
BoJ’s December surprise
Along with very low inflation, Japan has had very loose monetary policy for more than six years. The BoJ also initiated its ‘yield curve control’ policy in September 2016, setting its target yield for the 10-year Japanese government bond to zero with a tolerance band of plus-or-minus 0.1 percentage points.
“If there were a good time to drop the BoJ’s YCC policy, this looks like it,” he said. “The likely sequence for the BoJ’s ‘normalization’ path thus involves the removal of the YCC policy followed by more conventional monetary policy guidance for short-term rates, depending on the development of inflation and wages,” Monier said.
“We do not expect any change before April, when Kuroda departs and the fiscal year ends. Doing so beforehand would mean large investors such as pension funds and financial institutions could see big swings in valuations of their JGB holdings. If conditions continue to point to on- or above-target inflation, the BoJ may end its negative interest rate policy, though not any time soon. We believe that an adjustment in short-term rates is still unlikely this year,” he said.