As the guessing game over the timing of Japan’s next interest rate hike intensifies, another debate is brewing within the central bank over how high rates can rise, a question that could be discussed at this week’s policy meeting.
With markets expecting the Bank of Japan not to raise rates on Thursday, Governor Kazuo Ueda is expected to elaborate on the bank’s thinking on the future rate hike trajectory.
BOJ staff estimates showed that the bank considers it possible to raise short-term rates at least to around 1% without slowing growth, although some within the bank point out that the Recent lackluster consumption is a sign that the level could be lower.
The outcome of the debate will be key in setting the pace of future interest rate hikes, as the BOJ plans to raise its policy rate to near-neutral levels by early 2027.
Most analysts expect the BOJ to raise short-term interest rates, currently at 0.25%, by March, which will be a first step towards raising interest rates. interest at levels deemed neutral for the economy.
Takahide Kiuchi, a former BOJ board member, expects the bank to slow the pace of rate hikes once it raises them to 0.5%, as further increases will bring costs closer borrowing from neutrality.
“The BOJ probably thinks Japan’s neutral rate is slightly below 1 percent,” said Kiuchi, who expects the bank to raise rates to 0.5 percent in January and 0.75 percent in September. next year. “Once rates hit 0.5%, it will take a more empirical approach that closely assesses the economic impact of each rate hike.
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The BOJ ended a sweeping 10-year stimulus program in March and raised short-term interest rates to 0.25% in July, estimating that Japan was on track to sustainably achieve its target. inflation of 2%.
Mr. Ueda said the BOJ would raise rates to a level close to Japan’s neutral rate, that is, the level at which monetary policy is neither restrictive nor expansionary, if the economy continued to grow. straighten up.
The BOJ has produced estimates that show Japan’s real neutral interest rate, adjusted for inflation, is in a range of around -1% to +0.5%. This means that if inflation reached 2%, the Bank of Japan could raise rates by at least 1% without slowing growth.
Based on the current forecast made in October, the BOJ expects short-term rates to move closer to what it considers neutral “in the second half of the three-year projection period” until March 2027, which suggests a useful time after October 2025.
But there is no consensus within the BOJ on the precise definition of the neutral rate, in part because of the lack of credible estimates in a country where interest rates have remained around zero for more than two decades.
While central bank board member Naoki Tamura said in September that the central bank should raise rates to at least 1% by the end of next year, his colleagues have not said much of the neutral rate.
Some BOJ officials believe Japan’s neutral rate could be below 1%, underscoring the fact that growth and inflation lack momentum despite real borrowing costs remaining very low, according to three sources familiar with the matter. the bank’s internal discussions.
Japan’s economy grew by an annualized 1.2% in the three months ending in September, a slowdown from the 2.2% increase recorded in the previous quarter, as consumption n having increased by only 0.7%.
After peaking at 4.2% in January 2023, core inflation has steadily slowed to 2.3% in October and shows little sign of picking up steam, with wage-induced price pressure remaining subdued.
This data, coupled with moderate inflationary pressure from import costs, has led to a growing view within the BOJ that there is no need to accelerate rate hikes, the sources said.
If Japan’s neutral rate is estimated to be around 1%, the BOJ will have to raise rates at least twice. A lower estimate would reduce pressure on the central bank to raise rates as frequently.
The increase to 0.5% alone would place short-term rates at levels not seen since 2007-2008. They add that it is unclear whether the public will respond to the prospects of regular rate hikes.
“If the neutral rate is lower than expected, the BOJ should act cautiously, as raising it too quickly could cool the economy,” one of the sources said, speaking on condition of anonymity because it was not known. not authorized to speak publicly.
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