There is a consensus that the Bank of Japan will "turn" early next year, and the market will focus on the "neutral" interest rate level.

Zhitongcaijing · 10/23/2023 12:17

Zhitong Finance APP has learned that traders are betting that the Bank of Japan will almost certainly end its negative interest rate policy early next year, and the focus is turning to policymakers' views on Japan's "neutral" interest rate.

Analysts believe that this theoretical interest rate, which neither stimulates nor restricts economic growth, may be in a wide range of 0.5% to 2%, which is a huge challenge for investors.

As the neutral rate will guide the Bank of Japan as it normalizes monetary policy, it will also provide a key reference point for market pricing of Japanese bond yields, which will have implications for investments ranging from U.S. Treasuries to European and Australian bonds.

The Bank of Japan’s policy rate has been close to or below 0% for a long time image.png

Japan's overnight index swap curve shows that the possibility of the Bank of Japan ending negative interest rates before the end of this year is 20%, and by April next year, this possibility will rise to 100%.

Toshitaka Sekine, the former head of research at the Bank of Japan, expects the neutral rate to be at 1.8%, reflecting the Bank of Japan's inflation expectations for the next two years excluding fresh food and energy prices. He said further rises in 10-year sovereign bond yields could push the neutral rate to 2%.

Eiji Maeda, another former head of the Bank of Japan's research and statistics department, also said earlier this month that the neutral interest rate was around 2%. He said the Bank of Japan may end its negative interest rate policy as early as January next year and raise interest rates by 0.25% every six months thereafter. This means that if this pace of interest rate increases continues, interest rates may reach around 2% by January 2028.

Yoshimasa Maruyama, chief market economist at SMBC Nikko Securities, expects the neutral rate to be between 0.5% and 1.5%. He expects the Bank of Japan to begin a normalization process with an eye to raising interest rates to a lower limit of around 0.5%, a level that could be reached within a year.

Tetsufumi Yamakawa, chief economist at Barclays Securities Japan, said: "Assuming Japan's neutral real interest rate is -0.5% and the medium- and long-term consumer price index is 2%, the neutral interest rate will eventually converge to around 1.5%. Currently, The Bank of Japan may gradually guide short-term policy interest rates to 0.5%-1.0%."

Takeshi Yamaguchi, chief Japan economist at Morgan Stanley Mitsubishi UFJ Securities, said: "While we believe Japan's inflation expectations have moved away from zero or negative values, we still doubt whether the 2% price target has been fully anchored. Long-term inflation expectations are at The nominal neutral interest rate remains at about 1%."

Ryutaro Kono, chief economist at BNP Paribas Securities, said: "Japan's natural interest rate is about -0.5%, so if the 2% inflation rate continues, the policy interest rate basically needs to be raised to around 1.5%. However, after the zero interest rate policy has been In Japan, which has been in place for a quarter of a century, raising the policy interest rate to this level will put pressure on the financial economy. If the interest rate increase cannot keep up with the pace of rising inflation, the decline in real interest rates will trigger a depreciation of the yen and inflation. Spiraling risks.”

Naka Matsuzawa, chief strategist at Nomura Securities, said: "The neutral interest rate of 1.8% is a bit too high. It is doubtful that the Bank of Japan can raise interest rates to a neutral level during this business cycle without wage growth being stable enough. It will take quite some time before inflation reaches 2%."

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