BOJ Sends Dovish Signal After Rate Hike Sparked Market Meltdown

(Bloomberg) -- Bank of Japan Deputy Governor Shinichi Uchida sent a strong dovish signal in the wake of historic financial market volatility in Japan by pledging to refrain from hiking interest rates when the markets are unstable. 

The yen weakened by more than 2% against the dollar, bond futures spiked higher and stocks rebounded immediately after his comments, which were the first public remarks by a BOJ board member since the bank raised rates on July 31.   

“I believe that the bank needs to maintain monetary easing with the current policy interest rate for the time being, with developments in financial and capital markets at home and abroad being extremely volatile,” Uchida said in a speech Wednesday to local business leaders in Hakodate, northern Japan. 

He spoke after massive swings in Japanese stock prices over the past week, as benchmark indexes plunged into bear markets, followed by sharp rebounds. The reverberations of BOJ policy were also dramatic in currency markets, upending carry trades that were a mainstay for many global funds. The deputy chief suggested that the bank will carefully consider the state of financial markets in future decisions on rate policy.  

“I think it would be premature to assume that there will be no interest rate hike before the end of the year based on this statement, as it will depend on the markets and the economic trends in Japan and the US,” said Yuichi Kodama, economist at Meiji Yasuda Research Institute. “I believe that the BOJ will raise interest rates again before the end of the year to 0.5%.”

Economists surveyed Tuesday following market ructions had largely kept their rate hike outlook unchanged, with most expecting another increase by the end of the year.

Pricing in swaps markets, which tends to be volatile, is now pricing in just a 20% likelihood of a 25 basis points hike by the December policy meeting, down from more than 60% the day after last week’s move.  

Uchida said that authorities in Japan can afford to wait for the markets to calm before making any decisions. 

“In contrast to the process of policy interest rate hikes in Europe and the United States, Japan’s economy is not in a situation where the bank may fall behind the curve if it does not raise the policy interest rate at a certain pace,” Uchida said. “Therefore, the bank will not raise its policy interest rate when financial and capital markets are unstable.”

Uchida, a veteran policy architect, who was heavily involved with designing the BOJ’s massive monetary easing program that ran for more than a decade, is widely known for playing a prominent role in mapping out Governor Kazuo Ueda’s journey toward normalizing policy. The BOJ ended the ultra-easy policy in March with its first hike in 17 years. 

Uchida noted Wednesday that authorities need to monitor any potential impact on prices and the overall economy coming from market moves, and the trajectory for Japan’s interest rates could shift depending on that impact. 

It should be noted that the plan to continue raising rates “is conditioned by the phrase ‘if the outlook for economic activity and prices will be realized.’ On this point, the significant movements in stock prices and foreign exchange rates since last week would be relevant,” he said.

“As Uchida’s dovish speech shows, they’re looking for a fresh start,” Toru Suehiro, chief economist at Daiwa Securities wrote in a report Wednesday. That said, with public polls showing a generally positive assessment of last week’s rate decision, “the hiking cycle itself likely hasn’t ended yet,” he said. 

--With assistance from Sumio Ito, Brett Miller and Issei Hazama.

(Updates with more economist comments, background, market moves)

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