Preview: Close to 50/50 Chance in Bank of Japan Conducting Its 3rd Rate Hike of Current Cycle This Week as Policymakers Measure Risks

By Max Sato

(MaceNews) – The chance of the Bank of Japan board hiking its policy interest rate by another 25 basis points to 0.5% this week is close to 50/50 as the bank’s policymakers ponder various risks amid growing domestic and global uncertainties.

One thing is certain. The bank is staying the course of normalizing its policy by gradually lifting rates from zero and slightly negative at every third or fourth meeting. The BOJ under Governor Kazuo Ueda shifted gears toward normalization in March 2024 with its first rate hike in 17 years and an end to the seven-year-old yield curve control framework, following a decade of controversial mega monetary easing aimed at reflating the economy.

At stake is whether it should conduct its third rate hike of the current cycle on Thursday when financial markets are relatively stable as they have digested fresh geopolitical risks or whether it should wait another five weeks, until the Jan. 23-24 meeting, to get a better feel for the pace of wage increases in the next fiscal year starting in April, a key to supporting growth and preventing inflation from slipping below the bank’s 2% target.

Judging from the BOJ’s track record of being ahead of the game in the previous two rate hikes – in March (using anecdotal evidence of major firms raising wages at the fastest pace in more than three decades for the incoming fiscal 2024) and in July (again relying on BOJ branches’ interviews with smaller firms to confirm wage hikes were spreading) – the majority of the nine-member board is unlikely to shrink from taking action this week. But that is a close call.

“Given the persistent weakness in consumption, lack of political support for rises in interest rates, and little imminent upside risks to inflation, there is no need for the BOJ to rush,” Mizuho Research and Technologies Executive Economist Kazuo Momma told Mace News. “While my base case is that the next hike will be in January, it is not guaranteed. The next one could be in March or even later.”

Momma was assistant governor from March 2013 until May 2016. Previously, he was the director-general of the Monetary Affairs Department and the chief economist at the bank.

Nomura Research Institute Executive Economist Takahide Kiuchi, who was a BOJ board member from 2012 until 2017, thinks there is hardly any difference in the possibility between a BOJ rate hike this week and next month.

“The latest Tankan business survey confirmed the weakness of consumer spending and showed easing in upward pressures on prices, which together do not particularly back up an additional rate hike,” he wrote in a report last week. “Having said so, (the Tankan results) are largely within expectations, which means they are unlikely to have any big direct impact on the Dec. 18-19 policy meeting.”

The Tankan showed confidence among manufacturers was nearly flat with a faintly brighter tone in the December quarter, led by a sharp improvement for oil refineries and thanks to strong global demand for semiconductor-producing equipment and other machinery. The index showing sentiment among major manufacturers edged up to 14 (vs. consensus 12) in December from 13 in September while that for smaller manufacturers picked up to 1 (also above the median forecast of -1) from 0.

Sentiment among non-manufacturers was mixed. The index measuring sentiment among major non-manufacturers slipped back to 33 from 34 while the index for smaller non-manufacturers rose to 16 from 14. A sharp drop was reported by major retail chains as the lingering heat wave dampened demand for fall and winter clothing. Large hotels and restaurants saw their sentiment slump while their smaller counterparts felt business was better than three months earlier.

While near-term inflation expectations are anchored around the BOJ’s 2% price stability target, many firms polled in the Tankan continue to project a slight downward pressure in general prices (as opposed to just business costs) in the longer term, an indication that the pace of high wage hikes may lose some steam and a spike in the prices for food, energy and other necessities is set to ease off.

Major manufacturers on average forecast an annual inflation rate of 2.0% a year from now (2.0% in the previous survey), 1.8% in three years (1.8%) and 1.7% in five years (1.8%). Large non-manufacturers expect inflation at 2.0% in a year (1.9% previously), 1.8% in three years (1.7%) and 1.7% in five years (1.6%). Smaller firms continued to expect a higher rate of inflation around 2.5% in all timeframes, feeling the burden of high materials and labor costs.

“I largely agree with the BOJ’s official view that price developments are on track toward the BOJ’s base scenario, in which sustainable 2% inflation is established around the latter half of its economic outlook horizon,” Momma said, referring to the second half of the three-year period ending in March 2027.

“The BOJ’s communications also suggest that the policy interest rate will be raised to around 1% when its 2% inflation objective has been fulfilled,” he said. “Putting the inflation outlook and policy reaction function together, the most natural trajectory of the policy rate going forward is a 25bp hike every six months until it reaches in the neighborhood of 1% presumably around early 2026.” 

But Momma warns that the risks to the inflation outlook are skewed to the downside in his view.

“While the year-to-year CPI excluding fresh food and energy is 2.3%, if you further exclude the entire food category, it is only 1.6%,” he said. Moreover, services inflation is 1.5%, trimmed mean of CPI is 1.5%, and weighted median of CPI is only 0.8%.

“This indicates that the ongoing inflation, by metrics closer to headline, is still affected by earlier import cost rises including impact of a material depreciation of the yen,” Momma noted. “But this portion of inflation will further dissipate going forward. Whether internally created and therefore more durable inflation pressure will strengthen enough to offset dissipating import cost pressures is still uncertain.” 

Just like the BOJ board’s decision to raise rates in March and July reflected corporate plans for wage increases and their implementation for fiscal 2024, Momma points out that the BOJ’s confidence in its outlook will “critically depend on wage pressure prevailing in 2025.”

Governor Ueda told the Nikkei business daily last month that currently observed wage growth of 2.5% to 3.0% in nominal terms was consistent with a sustainable 2% inflation.

“In order for this pace of wage growth to continue, however, another round of base pay rises close to 3.5% next spring (in April) will be necessary,” Momma said. “While a wage hike of such a magnitude is quite possible, there are some concerns associated with decelerating corporate earnings, particularly in the manufacturing sector, and the uncertainty around the U.S. political and economic developments.”

U.S. President-elect Donald Trump has threatened to impose a 25% tariff on all goods from Mexico and Canada, and an additional 10% tariff on imports from China, all part of his drive to crack down on illegal drugs and immigration. Nobody knows whether tariffs will actually be imposed, whether exemptions will be granted, or whether retaliatory measures will be put in place.

On the domestic political front, fiscal policymaking may see some delays. There is no apparent resistance to rate hikes by the government of Prime Minister Shigeru Ishiba but since the ruling coalition led by his conservative Liberal Democratic Party lost a majority in the lower house in the Sept. 27 general election, the LDP has to pay attention to a much smaller conservative party in the opposition camp to win parliamentary approval for the annual budget and any other bill.

That party, the Democratic Party for the People, has agreed in principle to support the ruling coalition bill by bill. It has been advocating raising take-home pay for many households by jacking up the non-taxable personal income level and abolishing the extra levy on gasoline that has accounted for roughly half of the total tax on gasoline. The party does not have any official demands for monetary policy, and even if it did, its influence on the BOJ is expected to be limited.

At its last meeting on Oct. 30-31, the BOJ’s nine-member board decided in a unanimous vote to maintain the target for the overnight interest rate at 0.25%, as widely expected, after leaving it steady in September and voting 7 to 2 to hike the rate to the current level from a range of 0% to 0.1% in July.

Noting that real interest rates are “at significantly low levels,” the BOJ said it will “continue to raise the policy interest rate and adjust the degree of monetary accommodation” if economic growth and inflation evolve in line with its latest outlook.

Japan’s economic growth slowed to 0.3% on quarter, or an annualized 1.2%, in the July-September period from 0.5% q/q (2.2% annualized) in April-June. Private consumption posted the second straight rise but both business investment and public works spending slipped back and net exports plunged. Heading into the final quarter of 2024, real household spending posted a 1.3% drop on year in October for a third straight decline as unusually mild weather dampened demand for autumn clothing and other seasonal goods while consumers remain frugal amid high costs for necessities and sluggish real wages