Bank of Japan Bolsters Policy Normalization Efforts with Higher Rates & Less Bond Buying

BoJ Accelerated Policy Normalization

In stark contrast with its major counterparts who implemented aggressive tightening in recent years to curb soaring inflation, the Bank of Japan had maintained an ultra-loose policy setting. Aimed at fighting years of deflation and spurring economic growth after the Lost Decades, the plan was implemented in 2016 and involved yield curve control (YCC), negative rates and Quantitative and Qualitative Monetary Easing (QQE).

Amidst sustained price pressures, wage increases and faltering Yen, policymakers started taking some timid steps towards a less easy stance and eventually abandoned the negative rates regimes and the YCC in March. Despite this historic shift, officials maintained an accommodative stance and took a cautious and slow path to normalization, amidst an uncertain policy outlook and wanting to ensure a virtuous wage-price cycle.

With Wednesday's decision though, the BoJ bolstered its efforts to tighten policy. It delivered its second rate increase to "around 0.25%" ^[1] and said it will "continue to raise the policy interest rate" if the economy and prices evolve as projected ^[2], leaving room for further tightening. The bank also announced a plan to cut its bond purchases, starting in the current quarter. It aims to lower JGB purchases by ¥400 billion every quarter, so that they will nearly halve by Q1 2026 and lead to 7%-8% reduction in its holdings.

These decisive actions are supported by the inflation and wage landscape, since policymakers expect inflation to "increase gradually" at level "generally consistent" with their price stability target. Core CPI has printed above the 2% target for more than two years and they believe it will stay around that level. They also see the virtuous cycle from income to spending intensifying further, following recent wage increases ^[3]. The Japanese Trade Union Confederation (known as Rengo) total wage increases surpassed 5% for the first time in thirty-three years. ^[4]

However, officials warned that there are high uncertainties around their outlook and that they could increase their asset purchases again if necessary. Furthermore, Higher interest rates could lead to increases in house loan payments and risk harming broader economic activity.