Déjà Vu for BOJ Governor Ueda? Interest-Hike Strategy Stumbles on Its First Step

Dismantling Easing of a “Different Dimension”

Ueda Kazuo replaced Kuroda Haruhiko and became the thirty-second governor of the Bank of Japan in April 2023. The task Ueda was entrusted with by Prime Minister Kishida Fumio was to create a virtuous circle between wages and prices and to guide the Bank’s decade-long monetary easing of a “different dimension” toward an orderly exit.

Governor Kuroda took credit for eliminating deflation, boosting the economy, and increasing employment. The difficult task of cleanup fell upon Governor Ueda. He needed to unwind a complex monetary policy, consisting of yield-curve control simultaneously affecting long- and short-term interest rates intertwined with a three-tier negative interest rate policy. He also needed to dispose in stages the huge quantities of Japanese government bonds and exchange-traded funds that the BOJ had purchased. In addition, all of this needed to be done without disrupting the market.

After becoming governor, Ueda revised yield-curve control twice, and he simultaneously ended yield-curve control and the negative interest rate in March 2024. This did not cause market disorder for such fortuitous reasons as the US economy being stronger than anticipated and the achievement of wage increases and rising stock prices in Japan. Whatever the case, the reputation of Governor Ueda soared for dismantling his predecessor’s “Kuroda bazooka” easing policy in less than a year’s time. It was reported that Ueda was highly pleased with the way he had normalized policy.

Positive developments, however, often come with complications. An unexpected peril lay waiting for the April meeting of the BOJ Policy Board. This was a misstatement made at a press conference that was foreseen by no one.

Governor Ueda was asked at this press conference whether the yen-dollar rate was in a range that could be ignored regarding its effect on the trend rate of inflation, to which Ueda carelessly replied, “Yes.” Markets took this to mean the acceptance of a weak yen, and the Japanese currency depreciated sharply. Although a BOJ officer expressed surprise at “Yes” response, it was now too late.

A Quick Return to Policies Responding to the Weak Yen

The Ministry of Finance and the Prime Minister’s Office reacted hastily to the weakening of the yen caused by the BOJ. Kanda Masato, then vice minister of finance, advised the prime minister that the yen should not be allowed to depreciate further. Kanda then intervened to sell dollars for yen by an unprecedented amount when the yen fell to 160 against the dollar, a 34-year low, toward the end of April. Then, as revealed by a senior government official, Prime Minister Kishida summoned Governor Ueda to the Prime Minister’s Office on May 7 following the Golden Week holidays to admonish his careless statement and to have the BOJ affirm its vigilance regarding a weaker yen.

Following this meeting, Governor Ueda stated to reporters that the BOJ would carefully monitor the recent depreciation of the yen in the management of monetary policy. In this manner Ueda shifted policy toward a focus on foreign exchange. Six days later, the BOJ reduced its purchase of long-term government bonds by ¥50 billion from a monthly ¥6 trillion. While a small amount, Governor Ueda sought through this action to place upward pressure on the long-term interest rate and to stem the yen’s trend toward depreciation.

BOJ Governor Ueda Kazuo speaking to reporters at the Prime Minister’s Office on May 7, 2024. (© Jiji)

In fact, how to curb the inflation caused by a weak yen was becoming an important issue for the Kishida administration. The Prime Minister’s Office felt that the Liberal Democratic Party’s loss of every House of Representative by-election held toward the end of April (including one the LDP did not contest) was not just the consequence of issues surrounding politics and money but also the result of the Japanese people’s growing dissatisfaction with inflation. A senior government official reports that Kishida summoning Governor Ueda to the Prime Minister’s Office was an expression of this sense of urgency.

However, a slight reduction of the BOJ’s purchase of Japanese government bonds would not be enough to halt the yen’s slide. In June, the yen again weakened past the 160 mark, fanning the administration’s sense of urgency. Finance Vice Minister Kanda requested that the purchase of government bonds be sharply reduced in parallel with massive intervention in the foreign exchange market. Some members of the BOJ Policy Board voiced their growing concern about the upswing of prices caused by the depreciation of the yen. At the June Policy Board meeting, the decision was made to reduce the purchase of government bonds. However, the determination of specific policies was put off to the July meeting so as not to shock the market. The BOJ’s stance was to proceed carefully with normalization, a stance that accelerated the depreciation of the yen.

Consideration of the Political Schedule?

Governor Ueda, whose roots are in academia, favors a normal monetary policy based on mainstream economic theory. He gives priority to the Taylor Rule, which calculates an appropriate policy interest rate based on the rate of inflation and the GDP gap (the difference between the actual and potential GDPs). He refers to the appropriate value determined by the Taylor Rule to determine whether the degree of easing is suitable.

In August 2000, when Ueda was still a Policy Board member, he resolutely opposed the proposal by then Governor Hayami Masaru to reverse the zero interest rate policy. Ueda thought that it was too early to reverse policy based on the Taylor Rule. While the policy was reversed at that time, this was followed by the collapse of an IT bubble in the United States and the slowing of the domestic economy. As a result, Ueda acquired a reputation for keen discernment.

The interest rate, however, has remained unusually low ever since Ueda became governor, greatly diverging from what the Taylor Rule would suggest. A government official has remarked that Ueda thinks it is theoretically correct to adjust the degree of monetary easing while taking into account the risk of an upswing in prices resulting from a weaker yen.

Meanwhile, BOJ staff supporting Governor Ueda have been concerned about the political and economic situation in autumn and beyond. First, the Federal Reserve Board is anticipated to reduce the US interest rate in September. Second, the LDP will elect a new president (thereby picking a new prime minister) on September 27. Depending on the election’s outcome, it could also lead to the dissolution of the House of Representatives and a general election.

It is difficult to forecast the impact of an interest rate cut in the United States coinciding with an interest rate increase in Japan. Such an event has the potential to disrupt markets. Moreover, as the political season approaches, it will become difficult to adjust monetary policy due to the risk that it will be suspected of being politically motivated. For these reasons, BOJ staff concluded that if monetary policy is to be changed, it would be better to do so early and so advised Governor Ueda.

Fortunately, Governor Ueda and many Policy Board members viewed an early rate increase positively, and a contentious July board meeting was unlikely. While the expectation that a July rate hike would be skipped dominated the market, BOJ staff believed that increasing the overnight call rate by around 0.15 percentage points should not cause a major shock. The BOJ, however, engaged in no proactive communication in June and July, which later proved to be a fatal mistake.

At the July 31 Policy Board meeting, the BOJ decided to increase the target for the overnight call rate and to reduce by half the purchase of Japanese government bonds over the next 18 months. Governor Ueda stated that inflation of more than 2% has continued for a long time and that it has the potential of rising further. If the economy and prices trend in line with forecasts, another rate hike would be made. What Ueda meant to say was that he would implement normal monetary policy according to the Taylor Rule.

However, a half day later, following a meeting of the Federal Open Market Committee, Federal Reserve Chairman Jerome Powell strongly suggested a rate cut for September. Another half-day later, on August 2, share prices began to plunge on the Tokyo market. The cause was said to be uncertainties about the direction of the US economy and the yen’s sudden strengthening against the dollar. There can be no doubt that the BOJ’s rate hike being perceived as a complete surprise by foreign investors supporting the ascent of Japanese share prices since the start of 2024 led to panic selling.

A monitor showing the closing price of the Nikkei Stock Average when the Nikkei fell by 4,451.28, the largest decline ever, on the afternoon of August 5 in Chūō, Tokyo. (© Jiji)

Governor Ueda’s Déjà Vu Moment

In my January 11, 2023, article titled “The Ill-Fated Term Awaiting the Next BOJ Governor” (published in English on January 27), I wrote: “The normalization of monetary easing of a different dimension can be likened to removing the fuses one by one from the huge number of unexploded bombs buried in the financial system and the economy. Mistakes made in their removal, or in the timing for doing so, could set off a catastrophic explosion.” The recent market crash is a disaster ensuing from mistakes made in the timing for removing fuses and in communicating with the market.

The Nikkei Stock Average was already trending downward after marking an all-time high of 42,426 on July 11. The BOJ’s intervention caused the Nikkei to fall another 8,000 points to an intraday low of 31,156 in the first three trading days of August. Deputy Governor Uchida Shin’ichi responded by hastily giving an address where he sought to calm the market. He stated that the interest rate would not be increased while the market is unstable, thereby promising that there will be no further rate increases for some time.

Whatever the direct cause, the plunge of share prices immediately after a rate hike places Governor Ueda in a difficult position. Almost a quarter century ago, in 2000, Japan’s reversal of its zero interest rate was followed swiftly by the collapse of the US tech asset bubble. Coming under fire for its mistaken timing, the BOJ was pressured into quantitative easing. In the case of Black Monday of 1987, the BOJ’s hesitance to tighten monetary policy in the face of plunging share prices gave rise to an asset bubble. While no one can predict which outcome the future may hold, neither is one that Governor Ueda would want to see in this déjà vu moment. The BOJ has stumbled in taking its first step toward normalizing monetary policy.

(Originally published in Japanese on August 13, 2024. Banner photo: Bank of Japan Governor Ueda Kazuo holding a press conference on July 31 after a meeting of the BOJ Policy Board. © Reuters.)