In a nutshell

• The big picture in the Japanese economy is one of consistently positive GDP growth, an exceptionally tight labour market, and steady recovery in consumer prices.
• Against this backdrop, we think it is likely that the Bank of Japan (BoJ) will change its policy later this year, as a less accommodative stance becomes appropriate.

Evidence that the cycle is “maturing” in Japan is abundant. While some softness can be discerned in recent activity data, the big picture becomes clear when looking at the Japanese labour market. January saw the unemployment rate fall further to 2.4%, its low point since 1993 (see chart VIII, page 7). And, at 1.59, the jobs-to-applicants ratio has hit the highest level seen since the mid-1970s.

Real GDP growth has been fairly consistently positive since late-2014. Cyclical indicators are providing constructive signs for the near future, pointing to continued growth, as Japanese businesses and households feel more confident. Finally, assuming a severe protectionism-driven downturn does not materialise, the improved global backdrop and ongoing recovery in global trade bode well for Japan’s external sector, which has been a solid driver of the current upturn.

In such a context, it should not be surprising that a policy shift by the BoJ is in the cards. Financial markets have been speculating on this possibility, also hinted to by Governor Kuroda in public comments during recent months. We expect to see a BoJ policy adjustment in the latter part of the year.

The BoJ having thus far retained the most accommodative stance among major central banks, a change in policy looks increasingly justified based on both economic data and real-world considerations. The steady recovery in consumer prices, with headline inflation that exited negative territory in 2016 and has now reached an annual rate of +1.5% (also see chart VIII, page 7), offers macroeconomic support for such a shift.

Meanwhile, the BoJ also faces capacity constraints in its asset purchase programmes, having become an owner of huge portions of the domestic government bond and index ETF (exchange-traded funds) markets. The political and technical hurdles involved in expanding its purchases to other types of assets, such as municipal debt or foreign bonds, make such a scenario unlikely.