A Raise it is Then

[Update Added Below]

This was always going to be a tough decision to predict but I still have to say that I am surprised by this since I just do not think the economic fundamentals are present to merit this. As such, I fear this one is all about the carry trade and the international pressure to unwind the excess liquidity.

(from Bloomberg)

 The Bank of Japan raised its benchmark interest rate to 0.5 percent after the world's second- biggest economy expanded at the fastest pace in three years.

Governor Toshihiko Fukui and his policy board colleagues voted 8-1 to increase the overnight lending rate from 0.25 percent, the bank said in a statement today in Tokyo. Japan's rates are still the lowest among major economies. Deputy Governor Kazumasa Iwata voted against the increase.

The central bank said further increases will be gradual and that prolonging a low-interest-rate policy could spur investment bubbles. Higher rates may discourage investors from borrowing in yen to buy overseas assets, the so-called carry trade that helped drive Japan's currency to a 21-year low against its trading partners.

Of course, this is all about history too both very recent and more dated. Concerning the former the BOJ is acting on the basis of strong Q4 GDP figures which showed a rebound in consumer spending. However, it serves to remember here that if we include Q3 consumer spending was flat. Returning to the latter the BOJ is still haunted by the build up towards an asset bubble in the economy as was also the perceived impetus for the prolonged recession in Japan which began in the end of the 1980s and continued throughout the 1990s. But this seems extremely premature to me to make such a call at this point. In the end, I do consequently think that this decision was one where the BOJ tried to re-build its reputation and credibility with international markets following the flurry surrounding the recent policy meeting in the central bank. Of course, the political scene in Japan (most probably the MoF) is poised to strike ...

The government's ``chilly, tacit acceptance of the move was based on the reasoning that the BOJ would be left accountable for any subsequent slowing of the economy,'' said Shinichi Ichikawa, chief strategist at Credit Suisse Group in Tokyo.

In the end have two remarks on this ...

Firstly, I think the BOJ is playing a high risk game here and contrary to the market actors engaged in carry trade they are not hedged. It was never going to be easy for the BOJ to decide but by so clearly neglecting economic fundamentals of low inflation and sluggish consumer spending in order to cater for external pressures to unwind carry trade the bank is playing a game where ultimately its credibility is at stake since if the economy goes south the political scene will strike and strike hard as well as will international markets the day the BOJ has to revert back into ZIRP for example. This is of course by no means a straight forward call which is both good and bad for the BOJ ... it is good because the Yen is actually declining on the back of the interest rate decision which might seem a bit weird but the point is that this probably will be the last hike for some time. This of course will bring some much needed inflation to the economy and in any case Japan might be able to steer clear of the deflation associated with an appreciating currency. It is bad because it means that the carry trade will continue with undiminished power and as such this rate decision might actually have locked in the carry trades to an even larger degree than before, contrary to the objectives. This could also increase the international pressure on the BOJ to mover quicker and then of course we are right back at it albeit with slight difference that this time the rates are higher which will make the burden tougher on the domestic economy.

Secondly, this paves the way for my 'one-up-two-down' call which envisions how the BOJ might be forced back into ZIRP on the back of a premature hike. Of course, such flashy 'self-invented' economic forecasting is almost sure to fall short of reality so I can't say anything with certainty. However, I do think this is a distinct possibility at this point.

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