Japan Faces ‘Negative Spiral’ Risk, Warns Top MUFG Executive

The economic landscape in Japan is facing growing concerns regarding a potential “negative spiral.” This scenario arises when monetary tightening does not keep pace with rising inflation, coupled with a depreciating yen that exacerbates prices.

Market Concerns and Predictions

According to Hiroyuki Seki, the head of the Global Markets Business Group at Mitsubishi UFJ Financial Group (MUFG), markets have placed a 90% probability on a rate hike from the Bank of Japan (BOJ) this month. This increase in interest rates is critical as analysts focus on the central bank’s longer-term monetary policy.

The Potential Impact of Currency Depreciation

Seki highlighted that if the BOJ fails to manage expectations for future rate hikes, alongside potential government spending increases to address voter dissatisfaction with inflation, the yen might depreciate further. This could lead to re-accelerated import costs, further fueling inflation and creating a detrimental cycle.

Current Status of the Yen

Despite a narrowing interest rate difference with the United States, the yen remains weak, hovering around 155 to the dollar. This weakness has been attributed to market speculations about Prime Minister Sanae Takaichi’s reflationary policies, which may limit the BOJ’s tightening actions.

Importance of Monetary Normalization

To prevent a negative spiral of inflation and declining currency value, Seki emphasized the need for the BOJ to pursue a steady path toward monetary normalization. The central bank is expected to continue raising rates gradually, with an anticipated increase of 25 basis points approximately every six months, pending favorable economic indicators.

Interest Rate Projections and Strategies

The projected terminal rate, where the tightening is expected to conclude, stands at 1.25% to 1.5% by mid-2027. However, if inflation remains persistent, there is a risk that this rate may need to be adjusted higher.

Furthermore, the BOJ has identified Japan’s nominal neutral interest rate—one that maintains economic equilibrium—to be between 1% and 2.5%.

MUFG’s Bond Strategy

• Seki mentioned that MUFG is cautiously rebuilding positions in Japanese government bonds.
• The strategy grows particularly relevant as the benchmark 10-year yield surpasses 1.65%.
• Should yields exceed 2%, MUFG would expedite its bond purchases, focusing on 10-year bonds aligned with rising interest rates.

MUFG possesses significant purchasing capacity due to its current risk management strategy. As Japan navigates these economic challenges, the central bank’s decisions will be pivotal in determining the financial stability of the nation.