Despite a series of interest rate increases by the Bank of Japan, borrowing conditions across the country’s economy remain broadly loose — a sign that monetary tightening has yet to bite in a meaningful way.
The Bank of Japan has been carefully unwinding its ultra-loose monetary policy, nudging interest rates higher after years of holding them at or below zero. Yet by most measures, financial conditions in Japan — the overall ease or tightness of credit for households, businesses, and investors — have not tightened in step with those rate moves.
Loose financial conditions mean that borrowing is still relatively cheap and plentiful, credit is flowing, and the cost of money has not risen enough to slow spending or investment in a significant way. It is a situation that complicates the Bank of Japan’s task: rate hikes are meant to cool an economy and bring inflation toward a sustainable target, but they work best when they actually change the behavior of borrowers and lenders.
Several forces help explain the gap. The yen has remained under pressure against major currencies for much of the past two years, which keeps the effective cost of imported goods high but also supports Japanese exporters. Meanwhile, global investors continue to use the yen in what are known as carry trades — borrowing in yen at low rates and investing the proceeds elsewhere — which can dampen the domestic impact of rate increases.
Japan’s government bond market has also played a role. The Bank of Japan spent years buying vast amounts of bonds to hold yields down. Unwinding that position takes time, and longer-term borrowing costs have moved up only modestly relative to the policy rate changes made so far.
For the Bank of Japan, the persistence of easy conditions raises a question about pace. Moving too slowly risks allowing inflation expectations to drift higher or asset prices to overheat. Moving too quickly could jolt an economy that is only beginning to see wages rise in a sustained way after decades of near-zero growth in pay. Officials have signaled they intend to proceed gradually, watching the data closely before each decision.
Global investors are also watching Japan carefully. Any sign that the Bank of Japan is preparing another rate increase — or that conditions are finally tightening — can move currency and bond markets well beyond Japan’s borders, given the scale of yen-funded positions held worldwide.
Whether Japan’s financial conditions begin to tighten meaningfully will depend on the pace of future Bank of Japan rate moves and how quickly the effects feed through to lending and spending across the economy.
