In March 2024, the Bank of Japan
raised interest rates for the first time since 2007, lifting borrowing costs out of negative territory and calling time on decades of ultra-loose monetary policy as Japan emerged from a long period of entrenched deflation.
At the time, inflation had been above the central bank’s 2 per cent target for 22 months. Fast forward to today, and inflationary pressures continue to build. Although headline inflation fell to 1.3 per cent in February, this was because of the resumption of generous government subsidies designed to shield households from the energy shock caused by the war in Iran.
A more reliable gauge of inflation, the so-called core-core rate that strips out prices of energy and fresh food, stood at 2.5 per cent. A new measure that excludes temporary factors such as government subsidies was slightly higher.
Yet even though inflation has remained above the BOJ’s target for four straight years, interest rates have risen to just 0.75 per cent, leaving Japan with the lowest real borrowing costs among the leading central banks. However, there is nothing normal about what is happening to Japan’s economy and markets. Even before the war in Iran erupted, domestic and external cross-currents were complicating the outlook for interest rates.
Prime Minister Sanae Takaichi’s fiscal stimulus programme has weighed on the yen – which is down about 38 per cent against the US dollar since February 2022 and is currently trading near levels that previously prompted intervention from Japan’s finance ministry – and triggered a dramatic rise in government bond yields.
While Takaichi is sceptical about the need for higher interest rates, the weak yen is fuelling inflation by increasing the cost of imported goods, sapping consumers’ purchasing power and making it harder for the government to tackle Japan’s cost-of-living crisis.