Can Japan's Economy Continue To Blossom If Bank of Japan Raises Rates? Apparently So.

Amid an economic climate of high interest rates in the US and a slumber among China stocks led by a downturn in the property market, Japan’s economy lies in stark contrast to the antipathy that investors are feeling elsewhere in the world right now.

Rising consumer prices, buoyed by a weak yen that has reaped big bucks for exporters over the last couple years in particular, and a central bank policy of continued negative interest rates have so far boded well for Japan, which posted 4.8% GDP growth in the second quarter this year.

Bank Of Japan’s Bond Buying Spree

Predictably, the Bank of Japan (BoJ) is stepping up to the table with a series of market and monetary interventions.

Typically, BoJ retains the lowest interest rates of anywhere in the developed world, with a negative interest rate policy on bonds vs. other sovereign bonds. This keeps the 10-year Japanese bond yield at a steady 10 basis points.

Lately, however, Japan’s 10-year bonds have been rising. Monday, they hit 0.775%, a level that was last visited in 2013. Many speculate that yields will soon top 1% as Japan moves away from its negative interest rate policy. As a result the BoJ stepped in with three unscheduled purchases of Japanese bonds since July (the latest one was Monday).

Naturally, a major concern of the BoJ is inflation, which while on course with expectations, is still around 2.2%-2.5% right now. The effects of the BoJ’s bond buying makes bond prices go higher while the move towards 1% interest rates stokes fear in Japanese home-buyers, 70% of whom have floating rate mortgages. Low interest rates have fueled property speculation in recent years.

But the potential impacts of a Japanese policy intervention are not quite so clear cut, say analysts, since growth in the country is still so strong.

“In the near term I think the Bank of Japan have made it clear that they are okay with a move in yields higher reflecting fundamentals. I don’t think they consider 1% a level at which is going to have any negative consequences for the economy and I think the focus right now is a bit more about controlling the pace of yen depreciation, making sure it doesn’t just tumble towards a dollar yen of 155 unabated,” said Izumi Devalier, Bank of America Corporations BAC Global Research Head of Japan Economics, on Bloomberg TV Monday.

The dollar yen is trading around 150 yen per dollar, which is near a multi-decade low for Japan’s currency.

Devalier expects the BoJ to reverse its negative interest rate policy sometime between December and April, with Bank of America’s forecast date for this being January 2024.

Impact On Japanese Firms

So what does that mean for Japanese exporters Toyota Motor Corporation TM, Takeda Pharmaceutical Limited TAK, Honda Motor Company HMC and Sony Group Corp SONY as well as for large financial services firms such as major Morgan Stanley MS shareholder Mitsubishi UFJ Financial Group Inc MUFG and Mizuho Financial Group Inc MFG?

Perhaps surprisingly, not a lot – and in fact, most economists remain very bullish on Japanese stocks still.

The latest Japanese economic survey out Monday, called the Tankan, showed surging optimism among manufacturers and non-manufacturers alike.

For big manufacturers, confidence rose a staggering 80% in the period from June to September, while confidence among non-manufacturers rose 17% to its highest level since November 1991. Both results beat analyst expectations by a wide margin.

Sluggish overseas demand is expected to hit exporters in the fourth quarter a bit, but companies in Japan are still ramping up investment in local and overseas operations, according to the latest Tankan data. Big companies surveyed in the Tankan said that they expect to increase their spending further by 13.5% in the next six months. That follows on from an 11.7% increase in capital expenditures in 2022.

"The stronger-than-expected improvement in the latest Tankan survey suggests that the economy will continue to expand at an above-trend pace, which is contributing to mounting staff shortages and persistent price pressures," Marcel Thieliant, head of Asia-Pacific at Capital Economics told Nikkei Monday.

For most Japanese firms, they price the yen at around 120-125 yen per dollar for their accounting purposes, meaning any weakness under that level is pure upside. In other words, the yen would have to strengthen considerably, by as much as 20%, for there to be any noticeable effect on earnings.

“I think one thing we have to make clear is that we don’t consider an exit from negative interest rate policy to be tightening and neither does the Bank of Japan,” Bank of America’s Devalier told reporters

Devalier said that anyway, when “push comes to shove” policymakers would ultimately choose to maintain a negative interest rate policy if the consequences of not doing so meant punishing exporters by allowing the yen to go too high.