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Japan: The End Of An Era?

While the rise in policy rates has had a reduced impact on markets, the end of the yield curve control could, in the long term, give a solid boost to the yen, which is still significantly undervalued.

By EC Invest

For the first time since 2007, the Bank of Japan (BoJ) raised its key rates, thus exiting a very long period of negative interest rates. What impact is your investments?

Decades of experimentation have come to an end

The first rise in Japanese policy rates in 17 years was slight. From -0.1%, the Bank of Japan's reference rate rose to 0.0%. Nevertheless, the symbolism of this decision is essential.

After decades of fighting deflation, the rise signals a return of confidence, and the Japanese monetary authorities believe they can keep inflation close to their target of 2.0%. This decision ends a long period of highly innovative monetary policy.

Since 1990, the speculative bubble bursting precipitated the collapse of the prices of financial assets and real estate, and Japan has become a real testing ground in terms of monetary policy. With negative interest rates, quantitative easing, repurchasing of financial assets, and control of the yield curve, Japan has become a forerunner of many monetary policy measures.

Although the results have not always been conclusive, it is clear that many of these measures have been used throughout the West, especially since the 2008-2009 economic and financial crisis.

Today, the Bank of Japan wants to turn the page. With the end of the hostile policy rate, it also announces the end of purchases of equity ETFs and the abandonment of the control of the interest rate curve and the ceiling for the interest rate on 10-year sovereign debt. A return to normality in a way which should make the Bank of Japan a central bank (almost) like the others.

Is inflation sustainably close to targets?

The question is whether the Bank of Japan has acted too quickly and whether inflation will always be close to its targets. It is not difficult to get out of inflation while the rest of the world struggles with far too high inflation rates, disrupted supply chains, and skyrocketing energy prices. But gradually, inflation returns to less worrying levels everywhere. Energy prices are much lower than after Russian troops entered Ukraine.

Will Japan stabilise inflation at the current level?

The news is not good at home. Indeed, the leading Japanese union has just obtained a 5% wage increase for 2024, which has never been seen in the country of the Rising Sun. But this surge only partially compensates for the past loss of purchasing power. For more than a year, Japanese workers' wages have been rising much more slowly than Western workers', affecting companies' purchasing power.

Therefore, the room for manoeuvre ''working for private demand to increase substantially is limited, especially since, with the end of interest rates, such creation will be (somewhat) more expensive. In addition, the labour force is declining.

After peaking at nearly 87 million in the mid-1990s, the population aged 15 to 64 steadily declines from 74 million at the end of 2023 to a further decline. Of course, many Japanese people are doing well in the future. It just delays performance. At the same time, the end of negative rates will somewhat support the yen, which is undervalued in the foreign exchange market. And a slightly cheaper yen will contain the price of imported goods, limiting inflation. Together, these factors do not suggest a high inflation rate in the future.

Therefore, the Bank of Japan's bet is far from being taken for granted, and one thing is sure: if the key rates are no longer hostile, they should not rise much. The zero rate should last.

Towards higher Japanese long rates?


Insignificant in absolute terms and supposed to remain an isolated case, this rise in Japanese rates finally impacts the yen exchange rate, which is primarily undervalued, mainly against the euro and even more against the US dollar.

For its future trajectory, much will depend on the rate policy of the US Federal Reserve(and, incidentally, the European Central Bank). The more they are pushed to reduce their key rates, the more the differential that separates them from Japan will be eroded, which could support the price of the Japanese currency.

But on the other hand, a Fed that has no choice and is forced to keep its rates high longer than expected should keep the yen under pressure. In the longer term, the end of the control of the yield curve could impact the evolution of the yen much more than the rise in key rates.

So far, the Japanese 10-year rate has been capped at 1.0%. If it is illusory to imagine that the BoJ will one day stop buying Japanese sovereign debt, the abandonment of this ceiling could allow Japanese rates to rise gradually and exceed this level. At the same time, US long-term rates are expected to fall, which should lead to an erosion of the bond market rate differential. And this could cause significant movements.

Japan is the largest foreign buyer of US debt, at a stage where many other countries (China, Saudi Arabia, etc.) are wary of it. Higher rates that would encourage the Japanese to keep their money in the country would result in a stronger yen but also increased difficulty in finding a buyer for US debt if that continues the slide we have seen in recent years.

The end of negative rates in Japan is limited in absolute terms and ultimately has only a tiny impact on the markets, which are Imbued with symbolism. The end of Japanese equity ETF purchases is also expected to have a limited impact when Japanese corporate governance is improving significantly, and investors have regained a taste for this market, which is very volatile and not too expensive despite the recent rise. On the other hand, the end of the control of the yield curve could allow Japanese rates to become more attractive.

A priori, an increase in interest rates synonymous with lower bond prices could be bad news for the Japanese government bond.

Nevertheless, higher Japanese asset and yen interest rates would offset any increase in bond yields. However, the Japanese currency is undervalued, and a return to near-equilibrium levels would mean significant gains on the exchange rate front for € based investors.

Therefore, we continue to invest in Japan on the bond market and the Tokyo stock exchange.

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