The Bank of Japan (BOJ) is now giving a clear signal that the era of low interest rates in the country may soon end.
This warning comes after one of the BOJ policy board members revealed that the ongoing tensions in the Middle East risked causing inflation (price increases) in Japan to surge beyond the set target.
In a meeting with business leaders in Fukuoka prefecture on Thursday, BOJ policy board member Junko Koeda explained that the move to raise interest rates was a reasonable action to curb inflation.
“It is appropriate for the central bank to raise interest rates at an appropriate rate to deal with high inflation, while taking into account its impact on the overall economy,” Koeda said.
According to him, the core inflation rate in Japan has actually reached around 2%. Coupled with the conflict in the Middle East, world crude oil prices are expected to remain high for quite a while.
This is what makes the central bank worry that prices in the Japanese market will become more expensive if not controlled from now on.
Investors Expect June to Be 'Determinant'
This latest statement further strengthens the predictions of economic analysts that the BOJ will raise interest rates at their meeting scheduled for June.
Previously, a summary of views from the BOJ meeting in April and speeches by several of their senior officials had already hinted at this more hawkish policy change.
Is This Step Risky for Japan?
Raising interest rates when oil prices are high actually has its own "risk". It is feared that it could slow down the Japanese economy because expensive borrowing costs can cause companies to reduce business activities and people to spend less.
However, BOJ Governor Kazuo Ueda previously stressed that the company will continue to tighten monetary policy to save the economy from falling even more severely.
Koeda, who is also an academic expert in macroeconomics and finance, is also optimistic that the Japanese economy can survive and will not experience a severe decline like during the global financial crisis or the pandemic era. This guarantee is based on:
Technology Demand: Very strong global demand for the global technology sector (such as chips and artificial intelligence - AI).
Government Support: Various economic stimulus measures that have been provided by the Japanese government to support local businesses.
What is the Impact on the Currency Market?
Generally, the increase in Japanese interest rates will have a strengthening impact on the Yen (JPY) currency and trigger a major wave in the global currency market.
For Malaysians, this means that the cost of importing goods from Japan (such as vehicle components or electronic goods) may become more expensive.
1. “Carry Trade” Unwinding
This is the most critical impact. For decades, the Yen has been used as the main currency for Carry Trade activities, a strategy where investors borrow Yen (because its interest is cheap/nearly 0%) to buy the currency of another country with high interest rates (such as USD or AUD).
What happens when JPY interest rates rise? The cost of borrowing Yen becomes more expensive, and the interest rate differential narrows.
Effect: Investors will panic and rush to close their positions in large numbers. They will sell their foreign assets and buy back Yen to repay the loans. This process is called unwinding, which causes the Yen to rise drastically in a short period of time.
2. Global Capital Outflow (Repatriation of Capital)
Japanese institutional investors (such as insurance companies and pension funds) are among the world's largest investors in foreign bonds (especially US Treasury bonds).
When interest rates in their own country (Japan) start to rise, domestic returns become more attractive and less risky.
They will repatriate their capital, meaning they sell US dollars (USD) or Euros (EUR) to buy Yen, thus putting selling pressure on non-JPY currencies.
The forex market will experience very high volatility, not only on the day of the announcement, but also for several weeks afterwards.
