The Bank of Japan is caught in a vise

As a result of global inflationary pressure, all central banks, with a few exceptions, direct their monetary policy to further tightening and wage a merciless struggle against rising prices.

Olivier de Berrange
Olivier de Berranger, IT director

The US Federal Reserve (Fed), for example, just raised its rates by 0.75% for the second time in a row, a very rare move. Among these exceptions, we find the Bank of Japan, which, despite the onset of inflation in its zone and a very low yen against the dollar, does not change course and maintains an ultra-expansive monetary policy. How to explain it?

Part of the reason is history. For thirty years, Japan has suffered a long period of stagnation and deflation caused by various crises that have hit its economy since the bursting of a two-headed speculative bubble in 1990 – the stock market and real estate. This unprecedented situation prompted the Japanese central bank to respond with measures of the same scale, known as unconventional. First by gradually reducing key rates to zero and then by implementing the first asset purchase program known as quantitative easing (QE) to increase liquidity. As a result, Japan now faces a stratospheric public debt of 250% of GDP. This heavy restriction leaves very little room for maneuver. Indeed, today the Japanese government cannot afford to bear the high cost of servicing the debt. Consequently, the Bank of Japan adopts a policy of “Yield Curve Control”, which consists of actively buying government bonds to limit yields at a very low level.

The return of inflation today in Japan is not a cause for concern, with inflation remaining very moderate at below 3% and wage growth in check. This development could even be seen as good news for the Bank of Japan, as it is the configuration it has been seeking for years. Furthermore, if we closely examine Japanese inflation, price fluctuations are mainly driven by changing exogenous parameters, namely energy and agricultural prices. As price pressures from global demand for raw materials begin to show signs of easing, this inflation may fade within a few months or even a few quarters.

However, such inflation, which is essentially imported, is unlikely to be considered healthy as it is not the result of strong growth or any domestic demand. Another alarming parameter is the Japanese currency. Indeed, the yen recently hit a 24-year low against the dollar. The situation is due to the differences between the monetary policy of Japan and the Fed, which still continue to increase. If the yen’s weakening continues, it could lead to higher inflation while slowing Japan’s economy, which is struggling to catch up to its pre-Covid-19 level.

In short, the Bank of Japan faces a serious dilemma: whether to maintain its yield curve control policy in the hope that inflation will fall, or to raise its rates at the risk of damaging its already suffering economic momentum. One thing is for sure: the archipelago’s central bank appears to be taking full credit for this delayed reaction, as is the ECB. Doesn’t this foreshadow the structural flaws in which the central banks of the G7 countries fall, more and more prisoners of low interest rates? The ECB still has zero rates at 8.6% inflation. The Fed itself, which just raised its rates to 2.50%, is starting to change its tune while inflation is at 9.1%. Can the developed world as a whole afford to raise rates in a sustainable but mostly efficient way? The future will tell, but we can doubt it.


The reported information is the result of an internal study carried out by the management team as part of its UCI management activities and not a financial analysis activity within the meaning of the rules.

This analysis is based on the best sources we have and on publicly available information. They do not in any way bind La Financière de l’Echiquier and do not constitute investment advice.