Japan ends loose monetary policy

Japan’s central bank plans to end its most loose monetary policy in two decades. This could have major consequences for the Dutch economy, among others, economist Edin Mujakic considers.

Japan’s central bank chief Kazuo Ueda told a conference that the central bank’s challenge would be to end the ultra-loose monetary policy of the past two decades. Ending that policy would, among other things, remove the cap on how far Japanese long-term interest rates could rise. For a long time, it was allowed to increase to a maximum of 0.5 per cent, but last week it was announced that the 0.5 per cent limit was not a hard ceiling but only a guideline.

Long-term interest rates are rising

As a result, long-term interest rates in Japan are now rising. According to Mujagic, this is a very important observation because Japanese institutional investors have long looked overseas to achieve decent returns due to low interest rates. ‘Japan has 125 million people, so a very large pension fund. Japanese institutional investors have bought a lot of government bonds in the US and from us. After all, we can’t get anything in our own country, but now that Japanese interest rates are on the rise, that will definitely change.’

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Given the sharp rise in interest rates, you’d think it would be interesting for the Japanese to continue investing in the US, but according to Mujajic, you’d be forgetting ‘half the story’, which is pension funds. The case also drives exchange rate risk. ‘That can be a very expensive joke, so you take out insurance to cover that risk. The cost of that insurance depends on the interest rate differential between the US and Japan. That difference has become so large recently that investing overseas almost by definition yields negative returns for Japanese pension funds.

Investors are bringing money back to Japan

Japanese institutional investors are therefore increasingly busy bringing money they have invested overseas into Japan. If this continues, they may sell large volumes of US and European government bonds. In total, Japanese investors hold about $3 trillion in foreign bonds, and approximately ten percent of Dutch government bonds are owned by Japanese investors. ‘So if there is any movement in this regard, it will have immediate consequences for us here. If they start selling those government bonds, that will put upward pressure on long-term interest rates here,” Mujakic said.

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Economists know that upward pressure has worried economists and policymakers deeply in recent months. Higher long-term interest rates make it harder for an economy to grow.