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Japan: Incoming BoJ Governor Faces A Delicate Balancing Act

DBRS Morningstar released a commentary titled “Japan: Incoming BoJ Governor Faces A Delicate Balancing Act.”

A combination of ultraloose monetary policies and external shocks have finally resulted in above target inflation in Japan. It is unclear if these dynamics will be sustained. However, if inflation persists, the Bank of Japan (BoJ) could be compelled to dial back its expansionary monetary policy stance. In such a scenario, incoming Governor Ueda will face a delicate balancing act when he takes over for Governor Kuroda later this week: to normalize monetary policy while maintaining financial stability.

Recent developments in the US and European banking sectors have illustrated the impact of sharply rising interest rates and their potential effects on financial stability. Shifts in monetary policy may lead to volatility in the local bond market, with potentially adverse implications for Japan's banking system. Normalizing monetary policy could also have implications for Japan's public finances. While Japan’s credit fundamentals remain relatively strong and support its A (high) rating, rising public debt levels and sharply higher rates could pose risks to the credit.

Key Highlights

-- Inflation is running above the Bank of Japan's 2% target but it is unclear if recent dynamics will be sustained.

-- If inflation persists, incoming Governor Ueda will face a delicate balancing act in normalizing monetary policy while maintaining financial stability.

-- In our view, the BoJ is likely to continue with expansionary policy until prices and wages are on a firm uptrend. While normalizing monetary policy could result in losses for some bondholders, we consider bank liquidity to be abundant, which significantly reduces the risk of needing to sell JGBs at a loss.

“Incoming Governor Ueda will face tough choices if inflation persists, as normalizing monetary policy in Japan could put stress on financial stability,” says Rohini Malkani, Senior Vice President, Global Sovereign Ratings. “Sharply higher rates could also reverse the downward trend in Japan’s debt-service ratio, which has been declining for over two decades.”