Bank of Japan’s comforting words, coming just a week after the rate hike—rather unparalleled in the once mystic world of central banking—is a testimony how the priorities of monetary authorities, once perceived as imperious freemasons in the world of money, are today intertwined with the fortunes in the financial markets.
It betrays the compulsions of central banks in a world that has become increasingly complex and unpredictable.
A rushed, reassuring soundbite by one of the world’s largest central banks—known for its unconventional doctrines and which has served as a reference point for peers—is very different from a government hastily rolling back an unpopular tax.
It’s simply a reminder of the changing role of central banks: irrespective of what their key objectives (inflation targeting, etc) may well be, central banks, like any government ministry or policy agent, have a prime role in managing expectations and avoiding any deep destruction of wealth, even if it’s notional.
Raising rates on July 31, BoJ Guv Kazuo Ueda said that the policy rate was “still very low even after a hike to 0.25%” leaving rattled markets world over with the possibility of another hike a few months later. However, on Wednesday (August 7), he made a carefully worded statement: “We won’t hike rates when markets are unstable”. The markets, which collapsed on July 31, regained some of the lost ground on Thursday. While he never quite said that rates won’t be raised in 2024, the two statements coming in quick succession brought to the fore the constraints of central banks.
For some, it was a sense of déjà vu. In mid-2000, the BOJ had ended its zero-interest-rate policy to increase the overnight call rate to 0.25%. It was a hint of recovery in an economy which had been deflationary pressures during the ‘90s. But amid a slowdown in the late 2000 and return of deflationary trends, the BOJ cut the policy interest rate to 0.15% in February 2001, paving the way for a “quantitative monetary easing” a month later.
Central banks had appeared as flawed icons after the global meltdown, and after salvaging economies hit by the crisis, their reputation may have taken a beating in the wake of the pandemic. But their powers remain undiminished as was borne out by the markets following the BoJ chief’s seemingly conflicting statements.
The development reinforces the now accepted overarching theme that the efficacy of monetary policy no longer lies in surprising markets as it once did. Rather, a large central bank, particularly whose sphere of influence spans continents, cannot afford not to adequately communicate to markets.
It’s a practice institutionalised by Ben Bernanke who believed in telegraphing in advance the thinking in Fed (unlike his now discredited predecessor who thrived in ambiguity). This assumes significance as many in the markets felt that even though BoJ had been dropping clear hints a comparatively steep quarter point hike was not adequately telegraphed. Indeed, BoJ’s quick change of gear would turn more central banks to air their views in advance and refrain from sudden moves.
Many may find it intriguing that BoJ didn’t quite anticipate the market reaction, given the huge yen borrowings by global investors to bet on markets.
However, besides factors like the rise of yen triggering carry trade unwinding and adverse impact on Corporate Japan which is highly reliant on exports, the outcry from households following a sharp drop in the stock market would also hold back most central banks from announcing surprise rate hikes. Thanks to a surge in household exposure to stocks and the culture of stock options, there exists today in most countries a large new constituency which is sensitive to market movements. No central banker can even dream of what Paul Volcker could pull off 45 years ago.
