Episode Details

After sending global markets in a brief tailspin in early August, the Bank of Japan is once again the center of attention. Our Global Chief Economist and Chief Asia Economist discuss the central bank’s next steps to help ease volatility and inflation.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.

Chetan Ahya: And I'm Chetan Ahya, Chief Asia Economist.

Seth Carpenter: And on today's episode, Chetan and I are going to be discussing the Bank of Japan and the role it has been playing in recent market turmoil.

It's Friday, September 13th at 12.30pm in New York.

Chetan Ahya: And it's 5.30pm in London.

Seth Carpenter: Financial markets have been going back and forth for the past month or so, and a lot of what's been driving the market movements have been evolving expectations of what's going on at central banks. And right at the center of it has been the Bank of Japan, especially going back to their meeting at the very end of July.

So, Chetan, maybe you can just level set us about where things stand with the Bank of Japan right now? And how they've been communicating with markets?

Chetan Ahya: Well, I think what happened, Seth, is that Bank of Japan (BoJ) saw that there was a significant progress in inflation and wage growth dynamic. And with that they went out and told the markets that they wanted to start now increasing rate hikes. And at the same time, the end was weakening.

And to ensure that they kind of convey to the markets that they want to be now taking rates higher, the governor of the central bank came out and indicated that they are far away from neutral.

Now while that was having the desired effect of bringing the yen down, i.e. appreciated. But at the same time, it caused a significant volatility in the equity markets and make it more challenging for the BoJ.

Seth Carpenter: Okay, so I get that. But I would say the market knew for a long time that the Bank of Japan would be hiking. We've had that in our forecast for a while. So, do you think that Governor Ueda really meant to be quite so aggressive? That meeting and his comments subsequently really were part of the contribution to all of this market turmoil that we saw in August. So, do you think he meant to be so aggressive?

Chetan Ahya: Well, not really. I think that's the reason why what we saw is that a few days later, when the deputy governor Uchida was supposed to speak, he tried to walk back that hawkishness of the governor. And what was very interesting is that the deputy governor came out and indicated that they do care for financial conditions. And if the financial conditions move a lot, it will have an impact on growth and inflation; and therefore, conduct of monetary policy.

In that sense, they conveyed the endogeneity of financial conditions and their reaction function. So, I think since that point of time, the markets have had a little bit of reprieve that BoJ will not take up successive rate hikes, ignoring what happens to the financial conditions.

Seth Carpenter: But this does feel a little bit like some back and forth, and we've seen in the market that the yen is getting a little bit whipsawed; so the Bank of Japan wants to hike, and markets react strongly. And then the Bank of Japan comes out and says, ‘No, no, no, we're not going to hike that much,’ and markets relax a little bit. But maybe that relaxation allows them to hike more.

It kind of reminds me, I have to say, of the 2014 to 2015 period when the Federal Reserve was getting ready to raise interest rates for the first time off of the zero lower bound after the financial crisis. And, you know, markets reacted strongly -- when then chair Ye