Our Thoughts On the Japanese Economy

Our latest thoughts on Japan are inspired by a “Governor’s Corner” session with Bank of Japan Governor Ueda at the IMF annual meetings in Washington DC in October 2024, the January 2025 inflation data release and the increase in the policy rate to 0.5% on 25 January.

Although Ueda commented in October that headline inflation was above 2% (the long-elusive Bank of Japan target) and had been for 2 1/2 years, he was concerned that inflation expectations had remained around zero.

He commented that “When inflation expectations are so low, it takes a long time to change them.” One clear indication that they remain low is from the breakeven inflation rate between conventional and inflation-linked government bonds, which is still not yet at 2% (see chart).

Source: LSEG and Tier Co calculations, 24 January 2025.

That is so different to the situation in the rest of the world, of course.

With huge uncertainty he wanted to proceed “cautiously and gradually”. That seems exactly what is happening.  

With respect to the financial market ructions in the summer he thought he “maybe should have spoken more in July.”

The most interesting question posed to him at the IMF October meeting was “what keeps you awake at night?”. His answer was “the right size of normalisation. And how to allocate this”. It was a somewhat enigmatic answer. I thought the comment must have referred to the size of asset purchases. But when asked for clarification, he said his concern was where the natural real rate of interest should be. His answer was “somewhere between -1% and +0.5% but that each of these estimates comes with big confidence interval.” If 2% inflation is now achieved on a regular basis, then that points to nominal interest rates ending up at between +1% and +2.5%. We are still a long way from that. But money growth remains very weak and it seems likely that any further increase in rates will be gradual and modest.