BoJ Review: Too hawkish, too fast

At the July 30 meeting, the BoJ announced their plans to reduce bond purchase by three trillion JPY over the coming two years and hiked interest rate to 0.25%. Bond purchase is expected to be reduced by an additional of 400 billion JPY per month, to be roughly halved in June 2026. Moreover, the BoJ is taking a hawkish tilt in the July meeting by also hiking interest rate by 0.15% to 0.25%, not only a step wider than the previous 0.1% hike but also providing a hawkish forward guidance "If outlook for economic activity and prices are realised, will continue to raise policy rates and adjust degree of monetary accommodation accordingly". With the BoJ making close to no change to their trend inflation outlook (2024 down 0.3% and 2025 up 0.2%), the policy step seems to be too fast and stance too hawkish. Despite headline labor cash earning inches closer 2%, small to medium business found it difficult to match the pace of large enterprises wage growth due to profit margin constraint and will not be contributing as much to the sustained wage growth as BoJ hoped. Combined with Japanese residents unwillingness to spend, private consumption has been sluggish for the first half of 2024 and will restrain BoJ's steps towards more tightening. Our central forecast continue to see inflation lower than BoJ's forecast and see no more tightening for the rest of 2024 unless there is a phenomenal shift in spending behavior for Japanese residents but the BoJ may insist trend inflation will be higher in the coming years and raise by at least once this year.

The move does not seem to align with BoJ's assessment towards trend inflation and wages after 2024 CPI forecast was revised to 2.8% from 2.4% in April. Labor cash earning y/y was revised below 2% in previous month (Apirl) and inch closer to 1.9% in May. Wage is still expected to experience accelerated growth above after the historic results from March's wage negotiation. Even if the average wage hike does not meet the historic sub five percent negotiate for large firms employees, a three to four percent wage growth would be sufficient to bring real wage to positive and stimulates consumption. However, Japanese residents are turning to saving instead of consume at higher prices and thus we believe the impact of wage growth towards inflation will be less than BoJ's expectation. Moreover, PPI continue to stay below 1% four months in a row and is close to zero in June (0.2%), further reducing the impetus for business to raise prices.

Our central forecast sees inflation to flare up from wage hikes by a smaller magnitude than BoJ's own forecast and thus do not see any more hike in 2024. But further tightening is likely given the current forward guidance and if wage-inflation translation turns up, the probability is low on consumers' reluctance in higher price and business inability to sustainably hike wages in the coming year.