By Max Sato
(MaceNews) – Bank of Japan policymakers have taken another step forward with their third rate hike this cycle, but they are still only hallway through their mission of hauling the economy from the lukewarm super-low borrowing costs toward the brave new world of paying normal levels of interest on loans.
At its two-day meeting that ended on Friday, the BOJ’s nine-member board, as widely expected, voted 8 to 1 to raise the policy interest rate by another 25 basis points (0.25 percentage point) to 0.5%.
In its latest risk analysis, the bank didn’t mention U.S. President Donald Trump’s threat to impose stiff tariffs on Canada, Mexico and China and its possible impact on Japan’s growth or inflation. The BOJ already has a long list of geopolitical risks to watch out for, and so far Washington hasn’t targeted Tokyo for what it sees as manipulating the currency market to keep a trade surplus with the United States.
Global geopolitical and domestic political risks (a potentially fragile minority government) aside, the BOJ is comfortably in position to raise interest rates every six months, a gradual move by Group of Seven major economies’ standards. The bank has been cautious because raising overnight rates from near to sub-zero even at a snail’s pace could be like feeding patients accustomed to a bland rice gruel diet a double cheeseburger with French fries.
Citing “significantly low” real interest rates, the board repeated its latest conviction that it should be able to continue raising the target for overnight interest rates and “adjust the degree of monetary accommodation” without hurting economic activity.
Judging from some views expressed by board members last year, the bank is staying the course of lifting the rate to at least 1%, which could still barely provide a minimum safety margin for lowering rates when a global crisis hits.
Governor Kazuo Ueda told a news conference on Friday that bank officials cannot pinpoint where their conceptual interest rate that is considered neutral to economic activity stands in a wide range of about 1% to 2.5%.
Ueda said the bank’s view on the neutral interest rate has not changed since he took office in April 2023. “Looking at the range as a whole, we believe that there is a suitable (‘considerable’ in this context) distance from the neutral rate.”
Bank officials are trying to avoid a repeat of 2007-2008, when a brewing sub-prime loan crisis surfaced in BNP Paribas’ poor financial health and eventually derailed the BOJ’s policy normalization effort when it triggered the collapse of Lehman Brothers in September 2008 and caused a global credit crunch.
In March 2006, the BOJ terminated its quantitative easing policy and returned to an interest rate policy, loosely targeting long-run price stability at around zero to 2%. The central bank under the then governor Toshihiko Fukui followed up with another rate hike, taking the overnight rate target to 0.5% from 0.25% in February 2007, even though Kazumasa Iwata, one of the two deputies to Fukui, voted against the proposal by the chair of the board, accurately predicting that Japan’s low inflation was about to slip back into deflation.
Nearly two decades later, Governor Ueda, who had sat in the BOJ’s rate-setting panel from 1998 to 2005, told reporters on Friday that the bank is unlikely to fall behind the curve in its efforts to raise interest rates, noting that above-target inflation, which has been pushed up by high import costs, has not been boosted by domestic demand, and thus is set to ease to 2.0% in fiscal 2026 ending in March 2027 from around 3.0% now.
In their quarterly Outlook Report issued on Friday, BOJ policymakers basically maintained their medium-term moderate growth projections in the face of various headwinds while raising their inflation forecasts for the next 14 months as lingering domestic rice shortages continue pushing up processed food prices and import costs remain elevated amid the weak yen.
The board’s median forecasts: GDP +0.5% (vs. +0.6% in October) in fiscal 2024 ending in March 2025, +1.1% (vs. +1.1%) in fiscal 2025 and +1.0% (vs. +1.0%) in fiscal 2026: core CPI (excluding fresh food) +2.7% (vs. +2.5%) in fiscal 2024, +2.4% (+1.9) in fiscal 2025 and +2.0% (+1.9%) in fiscal 2026. The bank noted that risks to growth are “generally balanced” while those to inflation are “skewed to the upside” for fiscal 2024 and 2025.
This means inflation is expected to be anchored at around the bank’s 2% target in about two years but it could still face a downside risk if firms fail to keep raising wages at an annual rate above 3%, and thus failing to support consumer spending. CPI data for December released earlier Friday showed services costs rose 2.3% on year, far behind the 4.3% rise in goods prices. Real wages are falling from year-earlier levels, keeping many households wary of spending beyond necessities.
The BOJ is in the process of normalizing its policy by gradually lifting the rates from zero and slightly negative at every third or fourth meeting. The BOJ under Governor Ueda shifted gear in March 2024 with its first rate hike in 17 years and an end to the seven-year-old controversial yield curve control framework, following a decade of large monetary easing aimed at reflating the economy. The board stood pat in December, October and September after voting 7 to 2 in July to hike the rate to 0.25% from a range of 0% to 0.1%.