Compressing rate hike expectations
Forward guidance that increases rate hike discounts, Convincing Takaichi normalisation lowers LT JGB yields
The challenge
The market understands that the July meeting is not live, it is priced 2% for a rate hike. Even though the BoJ Outlook will substantially revise growth higher and probably tap inflation forecasts higher too. This confidence comes from the fact that BoJ hasn’t raised rates at back to back meetings in modern history (since a formal published policy meeting schedule began, post-1997). It doesn’t imply economic conditions don’t merit the move.
Furthermore, a rigid forward guidance regime requires that the BoJ now pause after each rate hike, give a few speeches, plant a few articles in the Nikkei and invest sufficient time preparing both the Cabinet Office and the market for the next rate hike. Such is the unnatural policy world we live in today. Neither 50bp rate hikes nor a rapid sequence of hikes are acceptable. Rate normalisation (a completely invented non-economic term) dictates a slow sequence of rate hikes that do not upset the stock market. Externalities, such as persistent loss of purchasing power for households is somehow easily tolerated.
This leaves a wanna-be proactive BoJ with only two choices: change the forward guidance system, or do what it can to influence the market outside of rate hikes. While imperceptible at times, under Gov Ueda, the BoJ has been essentially implementing the latter. Various forms of non-rate-hike normalisation steps have been taken between rate hikes over the past 3 years. Each one helping to restore BoJ credibility, particularly when each is managed without a punitive market response.
The problem is that most of these non rate hike measures have been taken. We really are down to the final stages where returning policy rates to neutral and delivering on the inflation target are all that is left. Yes, balance sheet reduction is still an option, but its negative dynamic with long-end JGB volatility, which links into Yen weakness, can be counter productive at times.
