Highlights:

• The Bank of Japan (BoJ) has stressed that inflation is driven by a supply shock, which is no good basis to establish the much-wanted positive wage-price cycle. As real household income decreases, inflation tends to die out.
• However, the recent inflation bout has cut into traditional price stickiness and thus may contribute to more active price setting. For this to happen, the recent first round of higher inflation and wage needs to be nurtured, i.e. the first cost-push inflation needs to be transformed into a virtuous demand pull-driven cycle. This warrants – at least for some time – strong monetary accommodation. Thus, we forecast the BoJ to stick to very loose QQE as its main policy tool over the next years. Over the longer run, we remain sceptical that the BoJ will sustainably achieve its 2% inflation target.
• One reason is the failure of the Kuroda BoJ’s massive monetary easing to live up to expectations. The current Ueda BoJ has also to assess the results of previous policies, and the side effects of the Negative Interest Rate Policy (NIRP) and Yield Curve Control (YCC). Scrapping these policies needs good reasoning, for which we see – with high uncertainties - a good window of opportunity in April. In its more fundamental policy review, Ueda will stress that the operating environment of monetary policy has improved and thus will “only” simplify the structure of the monetary policy tools. 
• Hopes of higher inflation have pushed up key rate expectations and on longer-dated Japanese government bond yields (JGBs). But, given the lack of significant increases in key rates, the further expansion of the BoJ’s JGB portfolio, and the expected downtrend in global yields, we forecast that there will be no further sustained increase in JGB yields. Instead, we expect a slight decline in long-dated JGB yields in the medium term. This reduces the risk of Japanese investors massively withdrawing funds from higher-yielding overseas bond markets, which could disrupt global bond markets.
• Even if the BoJ’s monetary tightening falls short of market expectations, the end of NIRP and YCC combined with the Fed’s key rate cuts will be enough to trigger a moderate appreciation of the Yen.

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