Pressure is building for Japan to give up its ultra-loose monetary policy

Last year saw some of the biggest synchronised monetary policy tightening around the world, involving both developed and emerging-market central banks. However, the Bank of Japan was an exception.

It justified maintaining a negative interest rate policy and yield curve control measures – which have pegged the 10-year Japanese government bond yield at around zero per cent since 2016 – as a way to stimulate the economy. But both economic and technical market factors are making this policy combination increasingly difficult to sustain.

The first challenge to this ultra-loose monetary policy is Japan’s rising inflation. Nationwide core inflation (that is, excluding fresh food and energy) rose 3 per cent year on year last December. While this figure is not as daunting as the numbers in the United States and Europe, it could be a sign that inflation in Japan is finally picking up, which raises the question of whether such loose monetary policy is still appropriate.

Low interest rates in Japan, in contrast to sharply higher rates elsewhere, have weakened the yen substantially. This has made imported goods, especially food and energy, much more expensive in the local currency. Higher interest rates could help stabilise the yen exchange rate and reduce imported inflation.