Japan’s central bank chief dogged by painful history of premature moves

Kazuo Ueda was outvoted 7-2 on that day in August 2000, but the prescient call made his reputation. Soon the dot-com bubble burst and the central bank had to ease policy again.

Twenty-four years later, history repeated itself—almost. On July 31, the Bank of Japan again decided to raise rates over two dissenting voices. This time, the leader of the majority was Ueda, now the bank’s 72-year-old governor. He argued that Japan needed to raise rates several times if it could.

Global markets swooned, Japan’s benchmark stock average suffered its worst day since 1987, and within a week, one of Ueda’s deputies had to take it back. Shinichi Uchida said there wouldn’t be rate increases when markets were nervous. There was no need to hurry with inflation mostly under control. And, in case anyone was wondering, Uchida said there was no daylight between him and his boss.

The flip-flop reassured markets, and stocks recovered almost all the ground they lost on their bad day. But it shows the tightrope Japan is walking as it tries to bring interest rates firmly into positive territory. The Federal Reserve and the European Central Bank got there years ago out of necessity because of high inflation. Japan, by contrast, ended its eight-year negative-rate policy only in March. Even after Ueda’s increase, the policy rate stands at just 0.25%.

Some economists don’t mind keeping rates at around zero semi-permanently—where they have been, after all, for most of the past quarter-century in Japan—and using government spending to prop up the country’s chronically lackluster demand.

That is not the consensus here, however. Most central-bank and government officials want to restore what they see as normalcy, and Ueda has faced pressure to hasten the transition. Similar pressure led to both the 2000 increase and another one in 2006 that was soon reversed because of the subprime-mortgage crisis in the U.S.

Meanwhile, politicians have more short-term concerns: Voters are complaining about inflation, which is caused in part by the weak yen lifting the price of imported food and energy. Ergo, the central bank should do something to strengthen the yen, which means raising rates.

As a younger economics professor doing a stint on the policy board decades ago, Ueda could afford to play the maverick. After he left academia to become governor last year, political concerns have weighed more heavily.

“I strongly believe that the BOJ shouldn’t have acted this time," said Nobuyasu Atago, an economist at Rakuten Securities Economic Research Institute and a former BOJ official. With growth sluggish and consumer spending down, “the obvious conclusion was to wait," he said.

Atago said Ueda’s assertion that he was responding to the data lacked credibility, and observers “had to make the disappointing interpretation that the bank acted because of politics and currency rates."

Ahead of the July 30-31 meeting of the BOJ’s nine-member policy board, the yen was hovering near a 37-year low against the dollar.

However, it was already beginning to bounce back when the board met. And prospects for a Federal Reserve rate cut were already beginning to undermine the investment strategy known as the carry trade, which relies on a big interest-rate gap between the U.S. and Japan.

At the meeting, one member said the bank could keep raising rates “in a timely and gradual manner" because a rate of at least 1% was likely neutral for the economy, neither stimulative nor restrictive. A member cautioned, however, “Normalization of monetary policy must not be an end in itself." The views were made public in an official summary of the meeting that doesn’t identify speakers by name.

Ueda himself had expressed caution about raising rates. He had said he didn’t want to miss a chance to achieve mild inflation and higher wages—suggesting that a premature increase could dial back inflation too far and lead to a slowdown.

A different Ueda showed up at the news conference after the July 31 decision. He said the economy was on track and the bank needed to act now to avoid sharper rate increases later—only to have his deputy Uchida offer the opposite view the next week.

“The Bank of Japan’s explanations are so volatile that they could undermine confidence in the bank," said Takahide Kiuchi, a Nomura Research Institute economist and former BOJ policy board member.

Ueda has his defenders who say the governor was just trying to move away from a highly stimulative interest rate. J.P. Morgan Securities Japan economist Ayako Fujita pointed to positive data on wages, which rose in real terms in June for the first time in more than two years, and said the BOJ was on track to raise its policy rate to 0.5% in December.

Still, expectations for an October rate increase quickly receded after the speech by Ueda’s deputy. Some economists say Japan isn’t strong enough to bear higher interest rates, especially if the stock-market volatility hurts sentiment.

Crédit Agricole economist Takuji Aida had already projected that Japan’s economy would contract this year because of higher interest rates and a potential slowdown in the U.S. economy, and he said it could get worse because of the BOJ’s latest move.

Aida called for fiscal stimulus equivalent to around $200 billion to jump-start growth. “The government has to cover the errors made by the BOJ," he said.