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The Bank of Japan took a hawkish stance for once, announcing an interest rate hike and a balance sheet reduction, demonstrating its determination to normalize policy.

Wednesday, July 31The Bank of Japan announced its latest interest rate decision, announcing a 15 basis point rate hike, raising the policy rate to 0.15%-0.25%.The Bank of Japan passed its interest rate decision with a 7-2 vote, and the market had previously expected it to remain unchanged.

At the same time, the Bank of Japan announced a plan to reduce its bond purchases by 400 billion yen per quarter and will no longer provideBondsBuy a range instead and offer a specified amount.The Bank of Japan voted unanimously to reduce its bond purchases, but less than expected by 1 trillion yen per month。

The new monetary market operation guidelines will take effect on August 1, 2024. Analysts believe that:

The Bank of Japan noted that inflation risks this year and next are skewed to the upside, which may be the reason for its action.If this outlook proves correct, the Bank of Japan could raise interest rates further.

After the news was released, the yen/dollar exchange rate fluctuated violently in the short term and currently fell below 153. Earlier, it quickly rose above 152. The Nikkei 225 index continued to fall after the Bank of Japan's decision, and the Japanese 10-year government bond futures narrowed their intraday losses after the Bank of Japan announced the interest rate.

"Beyond expectations" interest rate hike, "less than expected" balance sheet reduction

The Bank of Japan's "beyond-expectations" interest rate hike this time has led the market to estimate that the probability of a rate hike in July is only about 40%; and the balance sheet reduction was less than expected, with the market generally expecting purchases to be reduced to 5 trillion yen next month, and eventually halved within two years.

Specifically:

The current monthly bond purchase scale is about 6 trillion yen. The monthly bond purchase scale in July was about 5.7 trillion yen. From August to September, the monthly bond purchase scale was about 5.3 trillion yen. From October to December, the monthly bond purchase scale was about 4.9 trillion yen...

Monthly bond purchases will be around 3 trillion yen by the first quarter of 2026, and Japanese government bond holdings are expected to fall by about 7-8% by mid-2024.

The Bank of Japan added that an interest rate of 0.25% will be applied to the current account balances held by financial institutions at the Bank of Japan; it will reduce government bond purchases in a predictable manner, announce the scale of bond purchases each quarter, adjust the bond purchase plan as needed, conduct a mid-term review of bond purchases in June 2025, and evaluate the bond purchase plan at a policy meeting if necessary.

It is worth mentioning that before the announcement,Japan Broadcasting Corporation NHK, Nikkei Shimbun and Jiji News all pointed out the possible interest rate hike by the Bank of Japan. The bond purchase schedule for August-September was also announced as scheduled, and the purchase amount was reduced compared with the previous period.

There is an upward risk to prices, or further interest rate hikes

The Bank of Japan said:

As the economic outlook changes substantially, the loose policy will be adjusted and the actual interest rate will be significantly lower.

If the inflation outlook materializes, interest rates will continue to rise, and wage increases will be significantly higher than last year. Price risks in fiscal years 2024 and 2025 are skewed to the upside.

In terms of inflation forecast, the Bank of Japan willCPIWith a slight downward revision, core CPI excluding energy remained unchanged:

The core CPI in fiscal year 2024 is 2.5%, compared with the previous forecast of 2.8%; the core CPI in fiscal year 2025 is 2.1%, compared with the previous forecast of 1.9%; the core CPI in fiscal year 2026 is 1.9%, compared with the previous forecast of 1.9%.

The core CPI excluding energy is expected to be 1.9% in fiscal year 2024, compared with the previous forecast of 1.9%; the core CPI excluding energy is expected to be 1.9% in fiscal year 2025, compared with the previous forecast of 1.9%; the core CPI excluding energy is expected to be 2.1% in fiscal year 2026, compared with the previous forecast of 2.1%.

At the same time, Japan also stated:

The yen exchange rate is more likely to affect prices than before, and import prices are rising again. We must be vigilant against the risk of overshooting inflation.

Moreover, private consumption remains resilient despite price shocks, and recent corporate behavior is gradually shifting toward higher wages and prices.

The loose monetary policy environment will continue to support the economy, and real interest rates are expected to remain significantly negative.

Will the Bank of Japan take a more hawkish approach?

Analysts believe that this interest rate decision is not dovish. The Bank of Japan has committed in writing that it will raise interest rates further if the good economic activity and inflation outlook continue. This is the first time and the hawkish stance of the Bank of Japan we have seen under the leadership of Kazuo Ueda. Regarding the scale of bond purchases, Nick Twidale, an analyst at ATFX Global Markets, believes thatThe yen was hit hard by the Bank of Japan's bond reduction, which was much smaller than expected.

However, analysts Toru Fujioka and Sumio Ito believe that the yen’s weakness has reached a turning point:

The Bank of Japan raised its policy rate and also said it would slow its monthly pace of bond purchases to about 3 trillion yen in the first quarter of 2026. Governor Kazuo Ueda took those steps while signaling the bank’s willingness to press on with its normalization process, and Wednesday’s action is likely to fuel speculation that one more rate hike could come this year.Hours before the Federal Reserve’s upcoming meeting, the Bank of Japan’s hawkish tilt could mean a turning point for the beleaguered yen as traders bet that the gap between U.S. and Japanese interest rates will narrow. Any comments from the Fed suggesting a rate cut could be in place in September would support that narrative.

Izuru Kato, chief economist at OTAN Research, said:

The decision to raise rates was likely to correct overly loose monetary policy, reflecting the fact that the actual policy rate has gone deep into negative territory. Although the Bank of Japan has always explained that monetary policy does not target money, the weak yen must have been an important factor behind today's decision, given that it has hit small and medium-sized enterprises in rural areas of Japan.The rate hikes were small and symbolic. There is no need to worry about a faster pace of rate hikes, as the BoJ's rate hikes in March and July were only as large as a one-time hike by a regular central bank. This does not mean that the BoJ has suddenly turned hawkish. Going forward, the BoJ will remain cautious and avoid tightening policy too hastily.