The BOJ in the AI Era: Simultaneous Looseness and Tightness

Global AI investment is driving a round of demand expansion. Investments in data centers, chips, power equipment and related infrastructure have increased, driving up the financing needs of enterprises. As a result, stock prices are supported and market risk appetite has improved. The financial conditions seem more relaxed than before. But this does not mean that risks have disappeared, because the increase in asset prices still relies on the realization of corporate profits.

AI-related stocks are performing strongly, making it easier for investors to sense the market heat. However, a rise in stock prices does not always mean that the real economy has improved at the same time. If corporate capital expenditures increase but do not bring sufficient profits, market sentiment may quickly reverse. The Bank of Japan also warns that the risk of such a correction is worthy of vigilance.

AI enterprises are issuing more bonds to expand their investments. Large-scale bond issuance will increase the supply of bonds and thereby push up long-term interest rates. This brings about a contradictory phenomenon - the stock market is strengthening due to optimistic expectations of AI, while the bond market is under pressure due to the increase in financing demand. The financial conditions are not uniformly loose. Instead, there are tightening forces.

Artificial intelligence not only affects short-term demand but may also change long-term productivity. If technology improves efficiency and accelerates capital accumulation, the potential growth rate of the economy may increase. This will affect the position of the neutral interest rate. The neutral interest rate can be understood as the interest rate level when the economy is neither overheated nor undernourished. The Bank of Japan believes that it is still difficult to determine the overall impact of AI on it.

The Bank of Japan raised its policy interest rate to 1.25% in September, the highest level in 31 years. The central bank believes that strong demand for AI-related products may push core inflation above the 2% target. Governor Kazuo Ueda also emphasized that core inflation must be stabilized near the target level and that it is unacceptable to tolerate persistent overvaluation of prices. This means that future policies may continue to tighten.

Japan relies almost entirely on imports for crude oil, and most of it comes from the Middle East. If geopolitical conflicts push up oil prices, import costs will rise rapidly. The weakening of the yen will further amplify this impact. Import prices denominated in yen have risen largely, increasing the pressure on enterprises' raw material costs. This makes it even more difficult for the Bank of Japan to ignore the risk of inflation.

The Bank of Japan will hold a policy meeting at the end of October. Market expectations are that it may temporarily maintain the interest rate unchanged. However, the central bank may signal continued tightening. The Bank of Japan will hold a policy meeting at the end of October. Market expectations are that it may temporarily maintain the interest rate unchanged. However, the central bank may signal continued tightening.

When Japanese interest rates rise, it will change the attractiveness of overseas assets. In the past, with low interest rates, a large amount of Japanese capital flowed to overseas bonds and stocks. As the domestic yield in Japan increases, some of this capital may flow back. This will have an impact on global bond markets and exchange rate markets, and may also increase the cost of overseas financing.

Currently, Japan is facing multiple pressures simultaneously: strong demand for AI, inflation exceeding the target, energy shocks, a weak yen and interest rates moving upward. For investors, at such a time, they need to be vigilant about the short-term fluctuations of AI.