Reading Kuroda's Mind

“I Beat the Market; Time Is On My Side”

Source: https://www.mhlw.go.jp/english/database/db-l/r04/2211pe/2211pe.html

(Let’s imagine we can read the mind of Bank of Japan (BOJ) Governor Haruhiko Kuroda. I am not saying I agree with him. I’m just saying he has his reasons; he is not simply stubborn. BTW, Kuroda’s term ends on March 31, and the choice of his successor, most likely in February, will be the next big signal of future BOJ policy.)

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I fought the market and the market lost—and lost big. All those speculators who believed I had no choice but to raise interest rates on Wednesday (Jan. 18) sold to the BOJ a record ¥16.2 trillion ($125 billion) worth of Japan Government Bonds (JGB)—an amount equal to 3% of GDP. They believed that I could not resist market pressure. After all, by January 17 when the BOJ Policy Board began its two-day meeting, the market had already raised interest rates above my 0.5% line on the sand for 10-year JGBs.

            But I refused to cave. And guess what happened? Yields have fallen. In fact, the rates on 7-, 8-, 9-, and 10-year JGBs are now all at or below my target (see chart below). As a result, the price of existing JGBs is higher than it was when they sold them to the BOJ. [When interest rates go up, the value of existing JGBs goes down and vice versa.]

Source: https://www.mof.go.jp/english/policy/jgbs/reference/interest_rate/index.htm

            So, those who sold JGBs “short” lost boatloads of money. This loss will make them more hesitant to bet against the BOJ next time. [Selling short means borrowing JGBs, selling them, and then buying them afterward in anticipation that their price would have fallen by then. But if their value goes up, they have to pay more than what they sold them for, and they lose money.]

            Yes, I know that there are lots of economists and speculators who think it’s just a matter of time before the markets push rates up again and the BOJ is forced to yield. [Former BOJ official Nobuyasu Atago told Reuters that, “The BOJ can't keep on manipulating markets like this. At some point, it needs to let market forces drive yields.” Takatoshi Ito, occasionally mentioned as a dark horse candidate to succeed Kuroda, stated, “Mr. Kuroda argues that the BOJ hasn't started moving toward the exit [from its current policy]. But the BOJ has already put its shoes and coat on.”]

They think it will happen sometime after the new BOJ Governor replaces me because they believe the current policy is unsustainable. But they’re wrong. This policy is sustainable and time is on the side of the current policy.

Market Is Misreading Japan’s Inflation Trends

For one thing, these speculators are looking at headline numbers for Japanese inflation and see that, in December, Japanese-style “core” prices—i.e., all items except for fresh food—were 4% higher than last December. That’s the highest year-on-year rate of inflation in 40 years (see chart below).

Source: https://www.e-stat.go.jp/en/stat-search/file-download?statInfId=000032103932&fileKind=1

            In fact, both Nikkei and Kyodo mistakenly reported that the BOJ was considering raising its inflation forecast for 2023-24 to something above our 2% target. In reality, we kept our forecast the same, at 1.6% inflation for fiscal 2023 [which begins April 1st], and raised the 2024 forecast by just a smidgen to 1.8%.

            People who say this need to look more closely under the hood of the latest inflation numbers. They not taking into account the volatility of prices for food and energy, which we must import. Prices for both categories are now going down globally, as we had expected. On top of that, with the yen now stronger than in November, we don’t need to pay as much in yen terms for our imports of food and energy as we did a couple of months ago. That puts more downward pressure on inflation.

            Secondly, while the headline numbers look like a big leap compared to a year ago, that’s partly a statistical illusion. It’s due to a recovery of prices from their fall during Covid. If we look at the price level for US-style core inflation (all items except food and energy), core prices are lower today than they were pre-Covid. Moreover, core prices in December were no higher than they were in October (see grey line in the chart below). Consequently, as we go further into 2023, year-on-year comparisons will shrink.

Higher Inflation Needs Bigger Wage Hikes

When I first launched my monetary “bazooka” back in 2013, I truly believed this would cause a big shift in “inflation expectations” among companies and workers. If companies and households truly believed that inflation was heading to 2%, then workers would insist on higher wages, companies would willingly give it to them, and households would spend more today before prices went up later on. That increased demand would help push prices up. It would be a grand virtuous cycle, a self-fulfilling prophecy. All this could be done in just two years.

            Unfortunately, while I’ve conquered deflation, I’ve not yet reached the 2% target on a sustained basis.

            We’ve had a lot of in-house discussions about this. Most of us now believe that, without nominal and real wage hikes, monetary policy alone will not be enough to reach 2%. Unfortunately, nominal wage hikes have been dismal over the past dozen years. Companies are earning big profits but not spending them on wage hikes. And we’re still discussing why. Nominal cash earnings per month (including overtime and bonuses) in 2022 were just 2% over their level way back in 2010. (see chart at the top of this post.)

            That’s why my speeches repeatedly say we need sustained inflation with wage hikes. To reach 2% inflation, nominal wages need to go up by 3% per year. Here’s why: if productivity (GDP per workhour) goes up 1% per year, then, to afford a 3% wage hike, companies need to raise prices 2% per year.

            The big union federation, Rengo, is asking for a 3% hike in base pay this year and I hope they succeed. But there’s certainly no guarantee and the BOJ should not raise interest rates until we see the needed wage hikes. Polls of companies are not as encouraging as I had hoped. Companies divide pay hikes into “base pay,” which raises the wages of the entire workforce, and “seniority pay,” the average increase in wages per worker as workers age. The latter raises the wages of individual workers as the years pass but does not raise the overall wage bill. That’s because lower-paid new workers replace the higher-paid older workers as the latter retire.

            According to a Reuters poll of big companies, just 24% of them intend to raise base pay, but it’s not clear by how much. 29% will increase seniority wages, but not base pay. And 38% are still undecided. Some corporate giants like Uniqlo and Rakuten are planning huge wage hikes, as much as 40% says Uniqlo. But they are the exception. Equally important, big companies employ only a fraction of the workforce. The small and medium companies that employ 70% of all employees are not likely to provide significant hikes, if any at all, according to most economists.

            Besides, with companies fearing that the US will enter some sort of recession, many will be hesitant to raise base wages. They’re more likely to give one-off bonuses.

Look At American Inflation and Interest Rates

People who think the BOJ is wrong about Japan’s inflation need to take a closer look at the US, where the inflation picture is rapidly improving. As the Wall Street Journal pointed out, “While December 2022 prices were up 6.5% from a year earlier...annual growth has eased to levels that existed before the pandemic. Inflation observed during the past six months would extend to prices rising 1.9% over the course of a year, close to the average annual rate of 1.7% between 2010 and 2020.”

            Consequently, American interest rates are trending downward, and so the gap between American and Japanese rates has shrunk. That’s why the ¥/$ these days is around ¥129 instead of ¥150 like it was back in November. That reduces pressure on the BOJ to raise rates just to bolster the yen.

The Next Governor

I cannot guarantee what policy will be pursued by my successor; nor can I bind him to continue my policy. But I feel no need to change BOJ policy to “pave the way” for him with higher rates, as some observers have suggested.