Published on 24/01/2025
On Friday, Bank of Japan raised interest rates to their highest since the year 2008 financial crisis, signaling confidence in the economy. With inflation forecasts revised upwards, central bank anticipates stable prices, driven by growing wages.
The decision marks the BOJ’s first-rate hike since July last year and comes days after the inauguration of US President Donald Trump, who is likely to keep global policymakers vigilant ahead of potential repercussions from threatened higher tariffs.
BOJ Governor Kazuo Ueda said the central bank will keep raising interest rates as wage and price increases broaden, adding that there was scope to push up borrowing costs further before they reach levels deemed neutral to the economy.
But he offered few clues on the timing and pace of future rate hikes, saying the decision will be based on how soon Japan will see trend inflation sustainably hit the BOJ’s target.
“We don’t have any preset idea. We’ll make a decision at each policy meeting by looking at economic and price developments as well as risks,” he told a press conference after the policy decision.
At its two-day meeting concluding on Friday, the BOJ raised its short-term policy rate from 0.25% to 0.5% – a level Japan has not seen in 17 years. It was made in a 8-1 vote with board member Toyoaki Nakamura dissenting.
The widely expected move marks another step Japan is taking away from the deflation and stagnant economic growth that dogged the country for decades.
“The likelihood of achieving the BOJ’s outlook has been rising,” with many firms saying they will continue to raise wages steadily in this year’s annual wage negotiations, the central bank said in a statement announcing the decision.
The BOJ made no change to its guidance on future policy, saying that it will continue to raise interest rates if its economic and price forecasts are realized.
But it removed a phrase stressing the need to scrutinise risks surrounding overseas economies and markets, underscoring its conviction that solid US growth will underpin Japan’s economy – at least for now.
“Various data shows the US economy is in firm shape. Markets have been stable as the broad direction of Trump’s policies become clearer,” Ueda said.
The BOJ’s path is bound with uncertainty, however, with trade uncertainties and Trump calling for further rate cuts by the US Federal Reserve and similar action from central banks around the world.
“There’s very high uncertainty” on the scale of Trump’s expected tariff hikes, Ueda said. “Once there is more clarity, we will take that into our forecasts and reflect them in deciding policy.”
The yen rose as much as 0.8% to 154.845 per dollar following the policy decision, but pared gains after Ueda’s news conference. The two-year JGB yield briefly rose to 0.725%, a level last seen in October 2008.
Markets were pricing in one more 25-basis-point rate hike by the end of this year, unchanged from before Ueda’s comments.
“Their logic remains the same. They are still far away from neutral, so it’s natural to make an adjustment,” said Naka Matsuzawa, chief macro strategist at Nomura Securities in Tokyo.
“Unless the BOJ either changes the logic of rate hikes, or even raises the neutral point, which they have been mulling – about 1% – there’s not going to much room for the market to price in further hikes in the future.”
WHAT IS JAPAN’S NEUTRAL RATE?
In its quarterly outlook report, the board raised its price forecasts to project core inflation moving at or above its 2% target for three straight years.
It also said risks to the inflation outlook were skewed to the upside amid intensifying labour shortages, rising prices of rice and the boost to import costs from a weak yen.
Ueda said there was “still quite some distance” between the BOJ’s policy rate and Japan’s neutral rate, or the level that neither cools nor overheats the economy, signaling the bank’s readiness to keep raising rates steadily.
The BOJ’s neutral rate estimate has drawn strong attention by markets as it would show how far the bank could eventually push up borrowing costs.
The BOJ staff has produced estimates showing Japan’s nominal neutral rate to be in a range of 1%-2.5%. Many analysts see the neutral rate as somewhere around 1%.
Ueda said the central bank must raise rates gradually and in several stages as the neutral rate was hard to measure on a real-time basis.
“When rates approach neutral or slightly exceed that level, there will be some kind of reaction to the economy such as declines in housing investment,” he said. “We’ll try to respond before the impact becomes very large. But we will be gradually testing the waters in finding out.”
Saisuke Sakai, chief economist at Mizuho Research & Technologies, expect the BOJ to hike once every six months.
“The next rate hike will likely come in the July-September period, followed by another one early next year,” he said.
After taking the helm in April 2023, Ueda dismantled his predecessor’s radical stimulus programme in March last year, and pushed up short-term interest rates to 0.25% in July.
BOJ policymakers have repeatedly said the central bank will keep raising rates, if Japan makes progress in achieving a cycle in which rising inflation boosts wages and lifts consumption – thereby allowing firms to continue passing on higher costs.
Japan’s core consumer inflation accelerated to 3.0% in December, the fastest annual pace in 16 months, data showed earlier on Friday, in a sign rising fuel and food prices continue to push up living costs for households.
