Bank of Japan Projects Earnings Impact from Future Rate Hikes

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The Bank of Japan (BOJ) has for the first time released estimates on the potential impact of future interest rate hikes on its earnings, revealing that it could face a temporary loss of up to $13 billion if short-term borrowing costs rise to 2%. 

The estimates, shared in a research paper on Thursday, highlight the BOJ's intention to continue raising short-term rates, currently at 0.25%, to levels considered neutral for the economy in the coming years. The BOJ evaluated several scenarios, including one where short-term rates gradually increase to 1-2% over the next few years, with the gap between short- and long-term rates widening by 0.25% to 0.75%.

In the worst-case scenario, where short-term rates reach 2% and the spread increases by just 0.25%, the BOJ could incur an annual net loss of about 2 trillion yen ($13 billion) in fiscal years 2027 and 2028, according to estimates from the bank's monetary affairs department. However, the loss is expected to gradually decrease, and the BOJ's earnings are projected to turn positive around fiscal 2031.

Having ended a decade-long stimulus program in March and raised short-term rates to 0.25% in July, the BOJ believes Japan is close to sustainably reaching its 2% inflation target. Governor Kazuo Ueda has indicated that the BOJ is prepared to continue raising rates to a neutral level, around 1%, if inflation targets are met.

Typically, central banks earn profits when loosening monetary policy, as the yield from government bonds exceeds the interest paid on excess reserves. However, tightening policy increases expenses, as higher interest must be paid on reserves to absorb market liquidity.

After expanding its balance sheet to nearly 800 trillion yen during years of aggressive asset purchases, the BOJ reported a record recurring profit of 4.6 trillion yen in fiscal 2023. However, profits are expected to decline as the bank begins paying interest on excess reserves and rolls over low-yielding bonds. 

As part of its quantitative tightening (QT) plan, the BOJ intends to reduce its monthly purchases of Japanese government bonds (JGBs) to 3 trillion yen by January-March 2026 and will conduct a mid-term review of the plan in June 2025 to develop a tapering strategy.

Paraphrasing text from "Reuters" all rights reserved by the original author.