Mizuho expects the Bank of Japan to accelerate rate hikes: embracing inflation-hedging assets, long-term bond yields will be under pressure

According to Zhitong Finance APP, Mizuho Financial Group expects that with the weakening yen and rising inflation prompting the Bank of Japan to accelerate its policy actions, the central bank may quicken the pace of rate hikes, with the next rate increase possibly coming as early as next month.

Kenya Koshimizu, Co-Head of the bank's Global Markets Division managing 41 trillion yen ($257 billion) of securities investments, also expects long-term interest rates to continue rising after the 10-year Japanese government bond yield hit a 30-year high this week.

Koshimizu stated that, for Japan’s third-largest bank, the result is that apart from inflation-linked government bonds (inflation-protected bonds) and bonds maturing within one year, the bank will continue to avoid buying Japanese government bonds. In an interview in Tokyo, he said: “We have limited the interest rate risk we take, so the duration of our portfolio is very short.”

His comments highlight that, as interest rates rise and inflation persists, many (though not all) Japanese financial institutions remain cautious about re-entering the Japanese government bond market.

Koshimizu pointed out that the probability of a rate hike in September is “quite high,” and the Bank of Japan may shorten the interval between policy actions from about once every six months to once every three months.

He stated, “Once the Bank of Japan switches to a three-month rhythm, it becomes difficult to slow down again.” He added that excluding the current inflation effect of about 1.6%, the current policy rate of 1% is still “deeply negative.”

Due to continued pressure on the yen and consumer prices, traders and economists are watching to see if the Bank of Japan will step up its pace of rate hikes. A former government official has even suggested raising rates at every policy meeting. Although the U.S. and Japan jointly intervened last month—marking their first coordinated effort to prop up the yen since 1998—the yen has already resumed its downward trend.

Koshimizu said: “The joint intervention was significant,” reflecting both sides’ agreement that a further depreciation of the yen is undesirable. “In addition, the yen’s weakening is partly due to Japan’s loose monetary policy.”

Mizuho’s securities investment portfolio reaches 41 trillion yen

According to people familiar with the matter last week, Prime Minister Sanae Takaichi’s government supports an imminent rate hike, with the next action possibly coming in September or October. Koshimizu stated that he does not rule out the possibility of two rate hikes before the end of the year, which would lift the policy rate to 1.5%.

According to overnight index swap market data on Tuesday, traders are pricing in a 78% chance of a rate hike at the Bank of Japan’s policy meeting on September 18.

Koshimizu said it is difficult to predict the Bank of Japan’s terminal rate because it depends on Japan’s economic developments. He added that, due to productivity improvements boosted by a boom in capital investment, the central bank’s estimate of the neutral rate—between 1% and 2.5%—may also be revised higher.

Koshimizu said that Mizuho remains “conservative” towards Japanese government bond investments because, given Japan’s nominal economic growth rate of about 4%, the current 10-year government bond yield of about 2.9% remains relatively low.

As of the end of June, the bank held about 20.6 trillion yen of Japanese government bonds, but the majority consisted of short-term securities maturing within one year. As of June, the average remaining maturity of Mizuho’s Japanese government bond holdings was less than one year.

Koshimizu said: “Given global structural changes and the investment boom, inflation risks remain skewed to the upside. Therefore, we plan to actively invest in inflation-linked government bonds.”

The weakness in Japanese government bonds is attributed by many market participants to Takaichi’s fiscal policies, including the decision to cut the food consumption tax for two years. However, Koshimizu does not expect a dramatic sell-off similar to what occurred when former UK Prime Minister Liz Truss launched her unfunded tax cut plan.

Koshimizu stated: “Once yields rise to a level more consistent with nominal growth, Japanese government bonds will have significant potential demand.” He added that Japan’s major banks, overseas investors, and even households could all become interested buyers of Japanese government bonds.

Koshimizu is optimistic about Japan’s growth prospects, saying the Japanese economy is undergoing a transformation not seen in decades, which has stimulated corporate activity and loan demand. As a result, he said that Japanese equities are “very attractive assets,” and the bank is investing in index funds.

He said: “Global structural changes are expected to have a positive impact on the Japanese economy. However, such periods also tend to bring greater volatility to the financial markets.”