Analysis-BOJ shows that the action matters more than the signs requested by Reuters

By Leica Kihara

JACKSON HOLE, Wyoming (Reuters) – For academics and policymakers gathered at the U.S. Federal Reserve’s annual Jackson Hole economic conference to debate how central banks can affect market perceptions of the course of monetary policy, the Bank of Japan would he could seem to get it right. in July when it raised rates for the second time.

In March, the BOJ finally managed to end eight years of negative interest rates. The following month he began to drop hints that he would trigger steady interest rate hikes if inflation remained on track to meet his forecasts.

The message was ignored by markets until last month. Then the BOJ backed up its calls-for-action signal: It lifted short-term rates to 0.25% from 0-0.1% in a surprise move that triggered a global selloff in carry trades that for most of a decade ago they had been financed with ultra-cheap Japanese yen.

The subsequent market rout forced the BOJ to back down and offer assurances that it would not hike again until markets stabilized. And yet, it showed that central bank communication has maximum impact when words are matched with action.

The BOJ’s experience matches findings from new research presented at this year’s Jackson Hole conference, where global central bank policymakers discussed ways to improve communication with markets.

The paper – “Changing Perceptions and Post-Pandemic Monetary Policy” – showed how it took substantial interest rate hikes by the Fed for the public and markets to fully understand how committed policymakers were to ensuring that inflation returns to the US central bank’s 2% target.

“Policy rate actions contribute to, and may even be necessary for, communication effectiveness, particularly when uncertainty about the monetary policy framework is high,” the authors wrote. “As our evidence shows, a timely response of the monetary policy rate to inflation matters not only for influencing immediate financial conditions, but also for signaling that policymakers are serious about responding to future inflation news.”

Certainly, Japan’s biggest increase in inflation was at 4.2% in January 2023, well below the US peak of 7.1%, which pushed the Fed to hold off on raising rates in June 2022. Japanese Inflation in July it was 2.7% and has remained above the BOJ’s 2% target for more than two years, with rising wage inflation starting to push up service prices.

In its current forecast in July, the BOJ expects core consumer inflation to hold around its target through the year ending in March 2027. It also warned that the yen’s depreciation could create inflationary risks that warrant steady hikes of installments.

“We expect that as inflation expectations remain stable at their new level of close to 2 percent, the BOJ will begin to normalize monetary policy rates,” IMF chief economist Pierre-Olivier Gourinchas told Reuters on Friday.

“Certainly, in our assessment, there is room for further normalization of monetary policy going forward, and policy rates will gradually increase over a period of time,” he said.

CLEARER GUIDANCE IS NEEDED

The BOJ said it is clear what would trigger rate hikes and that its policy decisions are more data-driven.

But the fact that it took an actual rate hike to get its message across highlights the communication challenge facing BOJ officials, including Governor Kazuo Ueda.

The key complaint among analysts was that despite stressing that it would be “data-dependent” to decide when to raise rates, the BOJ pulled the trigger before there were clearer signs that consumption would emerge from the crisis.

This led them to believe that the BOJ’s July hike was driven by a desire to shore up a sinking yen rather than strong economic data.

“The fundamental problem with the BOJ’s communication is that it was supposed to provide tough guidance to stem the yen’s declines, even though many measures of the economy were weak,” said Shigeto Nagai, head of Japan economics at Oxford Economics.

In a U-turn from July’s dodgy communication, BOJ Deputy Governor Shinichi Uchida this month assured jittery markets that he would not raise rates while markets remain volatile.

However, with a measure of calm now restored, Ueda returned to jawing again, telling parliament on Friday that the BOJ would keep raising rates at levels seen as neutral – neither stimulating nor tightening the economy.

To avoid confusing markets, the BOJ needs a medium-term framework with clearer guidance on the path of longer-term rate hikes, some analysts say.

While the BOJ issues quarterly forecasts of long-term growth and inflation, it does not have a Fed-style dot chart of policymakers’ rate forecasts, nor an estimate of the neutral rate.

Ueda said on Friday that there was not enough data to come up with a credible estimate of Japan’s neutral rate, though he added that the BOJ would keep trying.

“The main task of the BOJ is to take the market’s focus away from the next meeting or the next hike and focus it more on where rates are going to go in the medium term,” said Jeffrey Young, chief executive of US research firm DeepMacro. .

“It’s something we don’t have a lot of guidance on.”