Early countdown to Japan rate rise
TOKYO - Japan's long-term interest rates have been climbing recently in tandem with rising global trends and amid increasingly rife speculation that the nation's central bank will make another rate hike earlier than expected.
As widely anticipated, the Bank of Japan's (BOJ) nine-member policy board, including governor Toshihiko Fukui, kept interest rates on hold on Friday at the end of its two-day meeting.
But most analysts expect the BOJ to jack up its key short-term interest rate by a quarter percentage point to 0.75% from the current 0.5% as early as August, with some even betting on such a rate hike in July.
Although most analysts predict that the next rate increase will come after an election for the House of Councilors in July, Fukui and some other BOJ officials expressed the view recently that the central bank should not take such political schedules as the poll into account in managing its monetary policy. The election is widely expected on July 22, but could be delayed by a week, to July 29, if the current ordinary session of parliament, which is to close on June 23, is extended to clear a logjam of bills.
The Bank seems increasingly confident that the world's second-largest economy will keep expanding moderately and that still weak prices will also improve in the medium and long term. However, the BOJ policy board's unanimous decision on Friday to keep rates steady apparently reflects the central bank's desire to see more data to judge whether Japan's economic growth and price developments have become resilient enough to withstand an additional rate increase.
Among other economic data that may significantly influence rate policy in the next couple of months are the BOJ's tankan quarterly survey of corporate sentiment, due in early July, and figures on gross domestic product (GDP) growth in the April-June quarter, due in mid-August. The August policy board meeting is set for August 22-23.
On Monday, the Cabinet Office revised upward its estimate of GDP growth in the January-March quarter to an annualized 3.3% in real terms, or after seasonal adjustments, from a preliminary estimate of 2.4%. The figure marks the ninth consecutive quarter of growth. The revised data showed that GDP grew 0.8% from the previous quarter in real terms, compared with a 0.6% rise in the preliminary report.
"This shows that the national economy has been recovering steadily due to the rise in domestic demand," the Cabinet Office said. The upward revision was due primarily to stronger corporate investment than initially reported, which grew 0.3% on a quarter-on-quarter basis, compared with an initial report of a 0.9% decline. But growth in personal consumption was revised downward to 0.8 % from 0.9%. Brisk plant and equipment investment among non-manufacturing industries such as transportation and construction boosted the nation's overall corporate investment into positive territory.
The GDP deflator, a measure of comprehensive price changes, was revised downward from minus 0.2% to minus 0.3%, compared with the previous quarter, indicating that a departure from deflation has been delayed. The jobless rate slipped to 3.8% in April, the lowest level since February 1998. A tighter labor market could put pressure on both wages and prices down the road.
In late May, the Ministry of Internal Affairs and Communications said that the core Consumer Price Index (CPI), which excludes volatile fresh-food prices, edged down 0.1% in April from a year earlier. Although it marked the third consecutive monthly fall, the rate of decline was smaller than 0.3% in March. The core CPI slipped 0.1% in February, the first drop in 10 months.
The core CPI reentered negative territory due to lower oil prices than year-earlier levels. BOJ governor Fukui said recently that year-on-year changes in the core CPI are expected to stay around zero in coming months but will likely follow an upward trend in the longer term. BOJ policy-board member Kiyohiko Nishimura also said recently that the core CPI will likely start registering year-on-year rises in October.
In its semi-annual outlook released in late April, the BOJ forecast that the core CPI will rise 0.1% in fiscal 2007, which ends in March 2008, and 0.5 % in fiscal 2008. In its previous outlook released last October, the BOJ had predicted the fiscal 2007 rise in the core CPI would be 0.5%. In its April outlook, the central bank also estimated the nation's economic growth at 2.1% in real terms, or after adjustment for inflation, in both fiscal 2007 and 2008.
The government has yet to officially declare a victory over deflation, a downward spiraling of prices that has plagued the economy since an asset-price bubble burst in the early 1990s. The Paris-based Organization for Economic Cooperation and Development warned the BOJ late last month not to raise interest rates again before fully getting over deflation.
There are potential external risks to the current Japanese economic recovery, including a possible sharp slowdown in the US and China, Japan's two biggest export markets, as well as a possible further spike in oil prices and a possible meltdown in global financial markets.
Growth in the US economy slowed to a paltry annual rate of 0.6% in the first quarter, the worst performance in more than four years. However, the BOJ policy board members seem to share the view that the US economy will likely achieve a soft landing. As Fukui put it recently, global growth is becoming "more balanced", with the US slowdown being offset by strong growth elsewhere in the world, including in China.
In February, BOJ raised interest rates for the first time in seven months, by a quarter percentage point to 0.5%, in an attempt to rectify what the central bank itself views as the "abnormal" state of the credit policy.
The target for the unsecured overnight call rate, which the BOJ uses as the key target rate in the short-term money market, was increased to 0.5% from 0.25%. It was the first time since September 1998 that the key policy rate had been at 0.5% or higher.
The BOJ policy board also jacked up the official discount rate - which effectively serves as the cap on the overnight interbank rate because the BOJ provides loans to banks at the rate through its Lombard-type lending facility - to 0.75% from 0.4% per annum.
Fukui has repeatedly cited the dangers of keeping an ultra-easy monetary policy for too long and emphasized the need to carry out phased, small-margin interest-rate hikes to achieve sustained economic growth in the medium and long term.
The February rate hikes were the first since last July, when the central bank ended its unusual zero-interest policy of nearly six years as the world's second-largest economy was continuing to recover and gaining strength after a decade in the doldrums. At the time the BOJ raised its target for the unsecured overnight call rate to 0.25% from effectively zero and the official discount rate to 0.4% from 0.1% per annum.
Fukui has said in the past year or so that the driver of Japan's economic growth will gradually shift to consumer spending from corporate investment. But that apparently has not yet happened.
Personal consumption - a main engine of growth accounting for about 55% of the nation's GDP - is weaker than expected, largely because of lagging income gains, which keep consumers reluctant to loosen their purse strings as much as expected. Growth in personal consumption during the January-March period was largely attributed to the temporary factor of warmer-than-usual weather. Prices have also failed to rise as much as expected.
Rising long-term rates
The yield on the benchmark 10-year Japanese government bonds hit 1.985% at one point on Wednesday, its highest level since the BOJ ended its zero-interest rate policy last July. Only a month ago, the yield was hovering at levels around 1.65%. The long-term interest rates began to surge after Fukui said on May 17 that another rate hike is possible even when price rises remain stuck in the negative territory. He made the remark at a press conference immediately after the previous BOJ policy board meeting.
Fukui said at the time: "I'm not saying we can raise rates any time when prices are falling. But if we examine everything, it is possible to raise rates even when prices are falling." He reiterated that if people expect interest rates to stay low even while the economy is expanding, that could cause unwelcome sharp economic swings and misallocation of funds. But at the same time he added: "Those comments that we are determined to raise rates desperately are completely wrong."
In the US, the yield on benchmark 10-year Treasury notes hit 5.27% on Tuesday, its highest level in more than five years. In the US, a recent spate of upbeat economic data, including robust retail sales, has brightened the outlook for the world's largest economy and, as a result, expectations of a rate cut in the near term by the Federal Reserve have significantly receded. Weekly US employment data also showed that the number of workers filing new jobless claims was unchanged at 311,000 in the week ended June 9, compared with an expected increase of 6,000.
The Fed has kept its target for the federal funds rate, an overnight bank lending rate that helps determine rates on credit card, home equity and other loans, at 5.25%, after raising rates 17 times between June 2004 and June 2006 in order to nip inflation in the bud. Speculation of another rate increase by the Fed is now growing.
The European Central Bank, meanwhile, raised its key policy rate by a quarter percentage point to a five-and-a-half-year high of 4.0% last week. The ECB signaled on Thursday that it will raise rates again after already raising them eight times in the past 18 months to rein in inflation in the euro-zone economy.
Cheaper Japanese currency
Meanwhile, the yen has seen a precipitous decline recently against the US dollar and euro despite Japan's higher long-term interest rates. Japan's interest rates are still the lowest among industrialized countries. A wide gap between interest rates in Japan and those in the US and Europe has contributed to the recent accelerated weakening of the yen against the US dollar and euro.
A cheaper yen has significantly contributed to Japan's robust exports - a key driver of growth for the world's second-largest economy - by making them more competitive abroad and thereby shoring up the current economic recovery. To be sure, the value of the yen is still about two times where it was when major economic powers agreed on the Plaza Accord in September 1985 to correct an excessively strong dollar. But the real effective exchange rate for the yen has been much weaker. The BOJ's trade-weighted measure of the yen's performance against major trading partners has slipped to the same level seen at the time of the Plaza Accord.
Meanwhile, investors are continuing to pile on yen-carry trades to take advantage of the yen-dollar exchange rates. A sharp unwinding of yen-carry trades would push the Japanese currency higher, hurting the nation's exports. Global capital markets are also sensitive to moves by the BOJ because institutional investors, including hedge funds, are heavy users of yen carry trades, in which they procure the yen at a cheap rate and invest in high-yielding financial products, including stocks and currencies of emerging economies.
The dollar hit a fresh four-and-a-half year high against the yen on Thursday in New York - and then on Friday in Tokyo - following news that US wholesale prices rose more strongly than expected in May. The greenback exceeded the 123 yen level at one point in both markets.
Hisane Masaki is a Tokyo-based journalist, commentator and scholar on international politics and economics. Masaki's e-mail address is [email protected]