By Leika Kihara
TOKYO, Nov 10 (Reuters) - The recent volatile swings in global markets are putting greater attention on the Bank of Japan's assessment of financial conditions, a key component of its policy framework that could sway the pace and timing of interest rate increases.
With markets returning to some measure of calm after a steep selloff in AI stocks, many analysts expect the BOJ to keep raising interest rates, with the next hike projected to come as soon as December.
But the recent rout has
tested the central bank's view that brisk AI demand will underpin the economy, with the wealth effect from booming stock prices giving households and companies more spending power.
It has also put the spotlight on the BOJ's financial conditions language, which serves as a key gauge of how close its policy rate is to levels deemed neutral to the economy, thus offering clues on the pace and timing of rate rises.
While the BOJ's escalating warning over inflation risks has preoccupied market participants, the less discussed guidance on financial conditions may increase in prominence if the AI market rout keeps equity prices on a downtrend, some analysts say.
"The BOJ's basic view is that financial conditions remain loose, which won't immediately change just because stock prices are falling," said former BOJ official Tetsuya Inoue, who is now executive economist at Sony Financial Group.
"But if asset prices remain unstable, it may hurt growth by cooling corporate mood and spending from households with stock holdings. Depending on market moves, it could give the BOJ reason to put off a rate hike in December."
STOCK WEALTH EFFECT
The BOJ has stressed the need to continue raising interest rates to counter upside price risks and prevent underlying inflation from overshooting its 2% target.
It has also justified rate hikes by saying financial conditions are loose, pointing to low real borrowing costs, strong corporate funding demand and rising bank lending.
While describing interest rates and funding indicators as key measurements, the BOJ said it also looks at asset prices in gauging financial conditions since stock prices and exchange rates affect household and corporate spending.
"For example, the uptrend in stock prices likely contributed to a decline in firms' cost of capital and helped support private consumption through wealth effects," the BOJ said in its quarterly outlook report released last month.
Such a positive cycle might go into reverse if the stock market adjustment persists and hits Japan's once risk-averse households, who have recently piled into stocks to ride the AI boom.
Japanese households' stock holdings reached 486 trillion yen ($3.08 trillion) in June, BOJ data showed, up 47% from year-earlier levels, accounting for 19.3% of their total wealth.
"The stock wealth effect is small compared with the US, but could have a sizeable impact on consumption as many in the younger generation now hold stocks," said Seisaku Kameda, the BOJ's former top economist, who is an economist at Japan's Sompo Institute Plus.
At last month's policy meeting, the BOJ said financial conditions remained accommodative "in light of recent developments in asset markets," as well as data showing still-low real rates and funding costs.
But a summary of opinions from the October meeting, released on Tuesday, exposed a rift in how board members viewed the prevailing financial conditions, with some seeing little impact of past rate hikes, while others warned of the potential hit to growth.
In a sign of the board's increased attention, one member called for assessing financial conditions using three measurements: the real interest rate gap, corporate finance and the bank lending channel, and asset prices.
"Asset prices, in particular, are affected not only by monetary policy but other factors," as seen in rising stock prices driven by AI-related demand, the member said.
For now, markets will be on the lookout for how Governor Kazuo Ueda will describe the impact of the market rout on financial conditions in a speech due on November 30, which precedes the BOJ's next policy meeting on December 17 and 18.
"Theoretically, if stock prices fall, that would tighten financial conditions," a source familiar with the BOJ's thinking said, a view echoed by another source. The sources spoke on the condition of anonymity as they were not authorised to speak publicly.
"There's still some time before the December meeting," a third source said. "Nobody knows how markets would be behaving then."
($1 = 158.0000 yen)
(Reporting by Leika Kihara; Editing by Thomas Derpinghaus)
