The yen surged by 3 per cent and equities slumped after the Bank of Japan dashed market hopes of stimulus despite data showing the country had fallen back into deflation for the first time since 2013.
It means that Haruhiko Kuroda, the BoJ governor, confronts the most perilous moment of his three-year battle against deflation as a rising yen threatens to undermine the confidence of Japanese companies.
Mr Kuroda insisted he is simply waiting to judge the effects of January’s shock move to interest rates of minus 0.1 per cent, but his inaction highlights the BoJ’s increasingly passive and after-the-fact responses to weak data.
“We have kept monetary policy on hold this time while the effects of quantitative easing with a minus interest rate sink in,” Mr Kuroda said. “Those effects don’t appear in a month or two but I don’t think it’ll take as long as six months or a year.”
That timescale suggests the BoJ could ease policy again over the summer. Mr Kuroda, who has shown a preference for large, surprise actions rather than incremental easing, said the central bank will act “without hesitation” if further loosening is needed to reach 2 per cent inflation.
The broad Topix stock index closed down 3.2 per cent at 1,341 with banking shares especially hard hit. The yen was up 3 per cent at ¥108.2 against the dollar, close to its high for the year.
Mr Kuroda’s decision to keep rates on hold, when more than half of market analysts expected an easing, is partly a bet that a recovering US economy will come to the rescue. A neutral statement from the US Federal Reserve the previous night held open the possibility of a US rate rise in June.
Masaaki Kanno, chief economist at JPMorgan in Tokyo, said there were two ways to look at the BoJ’s decision. One is the central bank’s own explanation that negative rates are working but “it will take time for the results to come through”.
The other is less benign. “What is left in their toolbox is limited and Mr Kuroda has two more years. If the BoJ eases too soon . . . the toolbox might not be empty, but there wouldn’t be much left in it,” Mr Kanno said.
Despite no change to policy, the BoJ took a knife to its economic forecasts, predicting growth of 1.2 per cent instead of 1.5 per cent for the fiscal year to March 2017. It cut its inflation forecast, excluding fresh food, from 0.8 to 0.5 per cent.
The BoJ also changed its guess of when inflation will reach 2 per cent from the “first half of fiscal 2017” to “fiscal 2017”. Any further delay would mean admitting Mr Kuroda will not reach the target during his term in office.
Earlier in the day, data showed the headline consumer price index down 0.1 per cent on a year ago, compared with analyst expectations of no change, as weak commodity prices weigh on Mr Kuroda’s efforts to drive up inflation.
But while prices continue to stagnate, there was better news from Japan’s labour market, with the unemployment rate down from 3.3 per cent to 3.2 per cent and the ratio of job openings to applicants up 0.02 points to a new 25-year high of 1.3 times.
A tightening labour market will eventually push up wages and lead to higher inflation, the BoJ hopes.
The central bank voted to keep rates on hold by a majority of 7-2. The only change was a minor subsidy to earthquake-hit banks on the southern island of Kyushu, providing them with zero-interest loans and exempting more of their balances from negative interest rates.
With funds for reconstruction already pouring into Kyushu, local banks have seen a rise in deposits, forcing them to bear a greater burden of negative rates. The changes offset that.