Japan is poised to join the “global club of normalised monetary policy” after the Bank of Japan announced its latest rate hike, which analysts said would help support equities valuations.
The Bank of Japan (BOJ) raised short-term interest rates to 0.5%, its highest level since the global financial crisis, following weeks of speculation over when governor Kazuo Ueda would hike again following last July’s surprise rate rise.
Japanese 10-year government bonds rose 0.02 percentage points to 1.22% and equities were mostly flat on Friday, a far cry from last July’s interest rate hike, which preceded a one-day flash-crash in Japanese equities and the unwinding of the yen carry trade.
Analysts noted that Friday’s interest rate hike marked an important step in the path towards Japan’s interest rate normalisation following years of ultra-loose monetary policy.
“While the rate hike itself was well-telegraphed, its real significance lies in the Bank signalling that Japan’s economy, buoyed by solid corporate profits and wage growth, might finally be ready to join the global club of normalised monetary policy,” said Chris Scicluna, head of research at Daiwa Capital Markets Europe.
Krishna Bhimavarapu, Apac economist at State Street Global Advisors (SSGA), noted that the key question would be when the BOJ would hike next, stating that he expects to see one more 0.25% rise this year.
“The key question for the future is whether the Bank maintains the current stance. Given the recent pivots and expected trade-related turbulences ahead, it is not guaranteed. Nonetheless we expect one more hike this year with the policy rate rising to 0.75%.”
Japan equities
The backdrop to the BOJ’s rate hike has been the increased foreign investor attention to Japanese equities, particularly after a strong performance in 2023, which saw the Nikkei 225 index jump 22.05% in US dollar terms (see chart).
Last year was more muted as the Nikkei 225 index advanced just 8.45% in US dollar terms following the unwinding of the yen carry trade in August.
According to research compiled by SSGA, in 2023 alone, foreign investors ploughed ¥6.3trn ($40bn) into Japanese cash and futures combined, buoyed in particular by corporate governance reforms, which have resulted in improving margins.
The normalisation of monetary policy has helped financial stocks in particular because of higher net interest margins, with Mitsubishi UFJ Financial Group earlier this month trading above its book value for the first time in years.
There have been concerns expressed though about the impact of interest rate normalisation on other sectors, particularly if this feeds through to a stronger yen, impacting the country’s exporters.
Yet, the consensus following the latest hike was that higher inflation would help corporate pricing power and earnings growth, while it may also trigger a surge in M&A among less competitive firms.
“Our investment views are intact: corporate reforms and mild inflation are helping corporate pricing power and earnings growth, keeping Japanese equities attractive. We remain tactically overweight and favour above-benchmark allocations in long-term portfolios,” said Ben Powell, chief Middle East and Apac investment strategist at the BlackRock Investment Institute.
Junichi Inoue, head of Japanese equities and portfolio manager at Janus Henderson also echoed these views.
“Now that price hikes and mild inflation are becoming more acceptable following years of deflation and weak sentiment, businesses are able to increase pricing power and profit margins, meanwhile higher financing costs will spur cost and debt reduction,” he said.
