The Bank of Japan’s determination to continue with gradual monetary tightening was reinforced when hawkish policymaker Naoki Tamura stated that the bank must raise interest rates to at least 1% by the end of the following year.
It was the first time a policymaker from the Asian country’s apex monetary authority openly stated the eventual target level for rising short-term borrowing costs by the central bank.
By late 2025, the central bank will need to raise interest rates to levels deemed neutral to the economy, according to Tamura, who stated that the chances of Japan’s economy sustainably reaching the Bank of Japan’s 2% inflation target were improving.
According to him, the neutral rate of interest in Japan is thought to be at least 1%. This rate of interest is the one that neither cools nor stimulates the economy.
“As such, it’s necessary to push up our short-term policy rate at least to around 1%,” by around the latter half of the fiscal year ending March 2026 to sustainably achieve the Bank of Japan’s price goal, Tamura said in a speech to business leaders in Okayama, western Japan, as reported by Zawya.
Tamura’s words come after a series of statements made by Bank of Japan board members urging the bank to continue hiking borrowing costs despite the recent volatility in the financial markets.
Interest rates in Japan were stuck at zero for over two decades, leading investors to borrow yen and invest in high-yielding assets. According to Deutsche Bank, the Japanese government accounted for USD 20 trillion in carry trade as of October 2023. The Bank of Japan ended negative interest rates in March 2024 and hiked short-term borrowing costs to 0.25% in July on the view Japan was making steady progress towards durably achieving its 2% inflation target.
Governor Kazuo Ueda has indicated that the bank is prepared to increase interest rates even more if inflation continues to hover around 2% in the upcoming years and wage growth remains robust, as the bank currently projects.
In a document filed with a government panel led by Prime Minister Fumio Kishida, Ueda said the economic environment remains accommodative, with inflation-adjusted interest rates negative even after a late July increase in the benchmark borrowing cost. That was the first in decades and triggered an unwinding of yen carry trades, destabilising risk assets, including cryptocurrencies.
However, analysts see the Bank of Japan’s plan to tighten monetary policy posing a challenge for risk assets because the United States Federal Reserve is likely to start cutting rates in September 2024 and other central banks are expected to do the same in the months ahead.
“That means the yen could be solidly bid against most currencies, including the dollar, potentially forcing traders to sell riskier investments and pay back their yen-denominated loans. The unwinding of the so-called yen carry trade rocked the global markets early last month and was partly responsible for BTC’s slide to USD 50,000 from USD 70,000,” reported CoinDesk.
Inflation Cools Down
Talking about Japan’s monetary policy, the Asian giant’s annual wholesale inflation slowed in August as the yen’s rebound weighed on import costs, something, which as per the analysts, will be taking some pressure off the central bank to address upward price risks with near-term interest rate hikes.
The corporate goods price index (CGPI), which measures the price companies charge each other for their goods and services, rose 2.5% in August from a year earlier, Bank of Japan data showed, slowing from a 3.0% gain in July 2024. It fell short of market forecasts for a 2.8% increase.
“The Japanese currency’s sharp rise during the month weighed on the yen-based import price index, which rose by just 2.6% in the year to August after a 10.8% spike in July, the data showed. On a month-on-month basis, wholesale prices fell 0.2% in August. The yen-based import price index also dropped 6.1% in August from the previous month,” reported Reuters.
Now, it needs to be seen whether the slowdown in wholesale inflation, which will affect the broader consumer price data in the coming months, will influence the timing of the Bank of Japan’s next interest rate hike (if it happens). Ueda has already cited the risk of an inflation overshoot from rising import costs as among the factors that led to the bank’s decision to hike rates in July.
He also signalled the Bank of Japan’s readiness to raise rates again if consumer inflation remains on track to hit 2% in coming years backed by solid wage gains, as the board projects.