TOKYO: The Bank of Japan’s rate-hike cycle is facing its biggest test since Governor Kazuo Ueda took the helm two years ago, with US President Donald Trump’s tariffs rapidly narrowing the window for further increases in still-low borrowing costs.
After the BOJ’s decision on Thursday to keep interest rates steady at 0.5 per cent, Ueda said the timing for underlying inflation to converge toward the central bank’s 2 per cent target has been “pushed back somewhat” – essentially signaling a pause in rate hikes for more clarity on the fallout from the higher tariffs.
But persistent food inflation, prospects of sustained wage hikes and fears of renewed falls in the yen may mean the BOJ has plenty of reason not to abandon its rate-hike plans altogether.
The delicate balancing act will likely mean the BOJ will keep signalling that its next move would be a hike, but leave markets guessing on the pace and timing of future action.
“The worst scenario for the BOJ is to end up further delaying achievement of 2 per cent inflation by proceeding with rate hikes amid high uncertainty,” said Akira Otani, a former top BOJ economist who is currently managing director at Goldman Sachs Japan.
“As such, the most desirable approach is to put off rate hikes as a precaution,” said Otani, who pushed back the estimated timing of the next rate hike by six months to January.
Goldman still expects the BOJ to eventually raise its policy rate to 1.5 per cent in the current rate-hike cycle.
On the surface, the threat to Japan’s export-reliant economy from the global trade war may be enough to ditch its rate-hike bias in favour of a more neutral monetary policy stance.
Under fresh forecasts released on Thursday, the BOJ expects the economy to barely expand above its potential this year. It also cut its inflation forecasts and saw risks skewed to the downside, a sign of its waning conviction on price momentum.
Ueda warned of “extremely high uncertainty” on the outlook, even as he stressed the BOJ’s resolve to keep raising rates on the view that underlying inflation will re-accelerate towards its target, after a brief period of stagnation.
History has proved the difficulty of normalising Japan’s ultra-loose monetary policy. The country has not seen short-term rate exceed 0.5 per cent in three decades, with attempts to lift them repeatedly hampered by stagnant wage growth and external shocks.
IS THIS TIME DIFFERENT?
This time, however, pausing too long is not without cost.
Unlike in the past when Japan was mired in deflation, core inflation has exceeded the BOJ’s 2 per cent target for three years as stubbornly high raw material costs prod firms to hike prices.
A shrinking labour force has also kept firms under pressure to hike wages and charge more for services, a trend Ueda said will continue and keep inflation on an moderate uptrend.
Steady rises in food prices, including a spike in the cost of staple rice, drove headline inflation to 3.6 per cent in March, drawing complaints from households and politicians.
“Attention is warranted to the possibility the recent rise in food prices may induce second-round effects on underlying inflation,” the BOJ said in a quarterly report on Thursday, warning for the first time the risk of food inflation turning into broader-based, longer-lasting price rises.
Ueda described the sticky food inflation since mid-last year as something that caught him off guard.
Sounding too dovish on the rate outlook would trigger renewed yen falls that add inflationary pressure and could draw the ire of Trump, who has accused Japan of intentionally weakening the yen to give its exports a trade advantage.
The yen dropped by as much as 1.1 per cent to 144.74 per dollar on Thursday, its weakest since Apr 10, after the BOJ’s gloomy forecasts heightened expectations it will take longer than expected to hike rates again.
Analysts at Morgan Stanley, who initially projected the next rate hike to come in September, now expects rates to be on hold at 0.5 per cent until the end of next year. But it sees a September hike as a risk scenario that could materialise if domestic inflation pressure heightens, or the yen weakens sharply.
“If the yen falls significantly while Japan’s trade talks are underway, the US may see such moves as a problem. A weak yen could not only push up inflation, but heighten government pressure on the BOJ,” they wrote in a research note.
“If so, and if uncertainty over US tariffs diminish, there’s a chance the BOJ could raise rates fairly soon.”
