(Bloomberg) -- The Bank of Japan ended the most aggressive monetary stimulus program in modern history, scrapping the world's last negative interest rate while keeping financial conditions easy for now — a dovish tone that weakened the yen after the widely expected decision.
The central bank set a new policy rate range of between 0% and 0.1%, shifting from a -0.1% short-term interest rate, according to a statement after a two-day board gathering that concluded Tuesday. The BOJ also scrapped the yield curve control program while pledging to keep buying long-term government bonds as needed. It also ended its purchases of exchange-traded funds.
The bank's indication that financial conditions will remain accommodative suggests this isn't the beginning of an aggressive tightening cycle of the sort seen in US and Europe in recent years. That stance appeared to disappoint some market players looking for a more aggressive rate outlook. The vote for the rate hike was 7-2.
The yen fell against the dollar from 149.29 just before the announcement to as weak as 150 afterwards. The move was relatively modest, with similarly subdued reaction in other markets. The broad Topix stock index rose about 0.4% while the Nikkei 225 Stock Average was little changed. Benchmark 10-year government bond yields edged lower.
In ending the negative rate, Governor Kazuo Ueda makes history by turning the page on the BOJ's experimental monetary easing program after years in which Japan's central bank was a global outlier. The policy gap now becomes even more stark as the BOJ makes its first upward move in close to 17 years just as its peers around the world are mulling cutting their rates after historically aggressive tightening campaigns.
Some investors were looking for a more concrete indication that rates would continue rising as Japan returned toward a conventional policy stance. Others may also have seen the majority vote as showing a degree of resistance to upward moves.
The BOJ couldn't say anything about the policy path toward additional hikes because it will depend on incoming data, said economist Yuichi Kodama at Meiji Yasuda Research Institute.
“But I think we should be ready for possibilities that the rate hike pace will happen faster than expected because wages are rising this much, which is likely to support consumer spending,” he said.
The BOJ's move comes as other major central banks are set to hold policy rates this month. The Federal Reserve is expected to hold interest rates at a two-decade high for a fifth month as officials meet later this week. The Bank of England is set to leave its key rate at a 16-year high of 5.25% at its March 21 meeting and the European Central Bank earlier this month left interest rates unchanged for a fourth meeting. The Reserve Bank of Australia announced earlier Tuesday that its cash rate target will remain at 4.35%.
High rates and a strong currency in the US have kept Japan's 10-year yields and the yen under pressure. The yield slipped as low as 0.725% after the decision, contrary to some expectations that it would rise with a rate hike and the removal of yield curve control.
The dynamic between Japanese and US rates is set to continue despite the BOJ's hike given ongoing strength in the US economy and resilient consumer spending there.
“This is a little bit like the party has started - but when are you coming next? Markets will push the BOJ,” said Alicia Garcia Herrero, Natixis SA's chief Asia Pacific economist.
The BOJ said its stable inflation target of 2% has come into sight as a virtuous cycle of wages feeding demand-led inflation is solidifying. Rengo, Japan's biggest umbrella group for labor unions, reported Friday that wage talks resulted in an initial deal for 5.28% increases, the best outcome since 1991. That fueled market speculation that the conditions were finally in place for a rate move after Ueda had repeatedly emphasized the importance of wage trends.
Some 38% of 50 economists surveyed by Bloomberg had expected the March rate liftoff, while another 54% predicted the move would come a month later. The survey was conducted before the strong results from annual wage negotiations that fueled widespread speculation the central bank wouldn't wait.
As part of its policy shift, the central bank said it would ditch its buying of real estate investment trusts, too. The BOJ adopted the highly unusual measure of buying risk assets like ETFs in 2010, ultimately becoming the biggest single holder of Japanese stocks, before buying operations slowed to only three instances last year. The optics of using the measure became increasingly awkward as Japanese stocks hit a record high this month, begging the question of why the equity market needed support.
What Bloomberg Economics Says...
“In our view, the BOJ moving even after recent data depicted wobbly growth and slack inflation hints at a strong resolve to normalize its policy even if the economy isn't in top shape.”
— Taro Kimura, economist
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Ueda, the first former academic to take the helm at the BOJ, had previously adjusted aspects of the ultra-easy policy settings he inherited when he became governor in April, tweaking the parameters of YCC in both July and October. Few analysts predicted Ueda would be able to unwind within a year so many policies that had become a headache for the central bank.
Ueda's predecessor Haruhiko Kuroda launched a shock-and-awe stimulus bazooka in April 2013 with the aim of achieving 2% inflation in two years. As that goal stayed out of reach, Kuroda adopted the negative rate and then the YCC program in 2016. His focus thereafter increasingly fell on enhancing the sustainability of these monetary settings with policy tweaks.
The prolonged monetary easing led to an expansion of the BOJ's balance sheet to the point where it's now worth 127% of the annual economy, four times bigger than the Federal Reserve's assets-to-economy ratio. Even so, inflation didn't really kick in until the supply shocks triggered by Covid-19 and Russia's war in Ukraine. Japan's key inflation gauge has stayed at or above the 2% target for 22 months, and that stretch is forecast to continue with national price data due Friday.
Ueda's post-decision press conference will begin at 3:30 p.m. in Tokyo. At that event he will elaborate on the thinking behind Tuesday's policy decisions.
--With assistance from Yoshiaki Nohara, Katia Dmitrieva and Yumi Teso.
(Adds market moves in response to decision)
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