Japan’s central bank has been cautiously trying to raise rates for over a year now. With the economy staying in the green, it had room to do so. But, now that the consensus of economists points to the first negative GDP reading since the start of last year, there could be some trouble in those forecasts.
At the last meeting, the BOJ kept rates unchanged, as was widely expected. What wasn’t expected was the drastic reduction in the forecast for GDP growth. This left the markets with a sensation that the BOJ was more dovish, and might not get around to another rate hike this year. As a result the USDJPY has been moving higher. It got a second wind with the dollar gaining strength in the wake of recent trade deals seen as supporting the US economy.
Prices or Growth?
The essential conundrum for central bankers is often whether to prioritize maintaining price stability or supporting the economy. Usually, those two problems go hand-in-hand. A slow economy doesn’t generate as much inflationary pressure. So, easier monetary policy ends up hitting two birds with one stone. The reverse happens when the economy overheats, as high inflation can be brought down by slowing down the economy.
But, when prices rise for reasons outside of the normal economic circulation of money, like with tariffs or export controls, then the situation becomes much more complicated for the central bank. Japan is a trade oriented economy. Not only does it rely on exports for growth, it also relies heavily on imports of essentials. Export barriers for its products, like steel and cars, on top of higher prices due to disruptions in the energy economy, can hurt Japanese consumers from both ends.
Inflation Above All
Since Kazuo Ueda took the top job at the BOJ, the Japanese economy has been in the green, and even surprising economists to the upside. This has allowed his signature move to bring interest rates out of negative territory and control the runaway carry trade that was weakening the currency. But now the BOJ might be running out of room in terms of economic growth, even as inflation remains well above target and climbing.
Deputy governor Shinichi Uchida gave some insight into how the BOJ might react in testimony before Parliament on Wednesday. There, he said that inflation might stagnate, temporarily. But the expectation was for wages to keep increasing, which would be passed through to the consumer affecting inflation. This underscored that the BOJ seems more intent on keeping inflation under control – even if that means the economy doesn’t stay in the green.
What to Look Out For
Japan Q1 GDP is expected to come in at -0.1%, well down from the 0.6% of the final quarter of last year. The annualized growth rate would turn to -0.2% from 2.2% prior, which would open the possibility of Japan entering a technical recession.
But, a negative number might not bother the market so much, since the BOJ already cut its growth forecasts at its last meeting. What could cause more of a shock to the markets is if the growth rate exceeds expectations. That could revive the chance of another rate hike this year, and give the yen a boost.
