The Bank of Japan has enacted an additional interest rate hike. Within the bank, voices are beginning to emerge that are conscious of the neutral interest rate, looking towards a potential hike up to 1% by next fiscal year. The picture shows Governor Ueda at a press conference, taken at the Bank of Japan headquarters on the 31st. (2024 Reuters/Issei Kato)
[Tokyo, 31st, Reuters] – The Bank of Japan has enacted an additional interest rate hike, but within the bank, voices are beginning to emerge that are conscious of the neutral interest rate, looking towards a potential hike up to 1% by next fiscal year. Governor Kazuo Ueda also mentioned that he does not believe the previous peak of 0.5%, during the rate hike phase since 2006, will serve as a “wall.” However, with events such as the U.S. presidential election approaching this autumn, there are concerns that they could disrupt the Bank of Japan’s scenarios. Including worries about the Bank’s finances, the interest rate hike strategy is likely to become challenging.
This rate hike is a “slight adjustment” amidst extremely low real interest rates
In a press conference following the monetary policy meeting on the 31st, Governor Ueda emphasized that the current real interest rates are very low, noting that even a 0.25% rate increase would not affect the real economy.
The day’s statement featured mentions of the current very low real interest rates twice, suggesting it was a factor supporting the decision to raise rates. Governor Ueda stated during the meeting that this rate hike is merely a “slight adjustment” amidst very low real interest rates, and he does not believe “strong brakes will be applied to the economy, etc.”
Governor Ueda cited the main reason for the rate hike as the fact that the economic and price situation has been progressing along the assumptions laid out in the outlook report. Prior to the decision meeting, there was a strong sentiment within the Bank of Japan that it was necessary to confirm the recovery of personal consumption through data; however, the Governor remarked that “personal consumption is firm.” He expressed optimism that wage increases would support personal consumption.
Voices for two more rate hikes within the fiscal year
At the Bank of Japan, voices are emerging stating that if the economic and price conditions progress smoothly, it would be desirable to raise the policy interest rate to 1% by the next fiscal year. Based on the additional rate hike in July, there is speculation that if there is one more hike within the year and another in the January-March quarter while observing next year’s spring labor negotiations, the policy interest rate could reach 0.75% at the beginning of the next fiscal year.
Such views are all aware of the neutral interest rate. In the April outlook report, the Bank of Japan indicated that Japan’s natural interest rate, which serves as the basis for deriving the neutral interest rate, is within the range of -1.0 to +0.5%. If we add the 2% price target to the lower limit of this range (which is -1%), then the lower limit of the neutral interest rate would be 1%.
The outlook report discussed during the decision meeting again projected that the year-on-year increase in the core consumer price index (excluding fresh food and energy) would hover around 2% by fiscal year 2026.
Governor Ueda has previously stated that “if the outlook holds for the latter half of the forecast period, the policy interest rate will be almost around the neutral interest rate,” but at the press conference on the 31st, he did not follow this statement, expressing instead that “when the policy interest rate approaches the neutral interest rate, where it will stop remains a big challenge,” and that they are “thinking while running” regarding where the terminal rate might be.
As interest rates rise, the challenges increase
Future rate hikes are likely to become increasingly difficult as interest rates rise. A rate of 0.5% is the peak from the previous rate hike phase, while 0.75% approaches the lower limit of the neutral interest rate, representing a level that anticipates a shift from monetary easing to tightening.
At the Bank of Japan, there are voices stating that as the policy interest rate approaches the lower limit of the neutral interest rate, favorable economic momentum will become a required condition for rate hikes. This contrasts with the decision regarding the 0.25% hike, where they did not wait for clear pickup in economic indicators reflecting personal consumption.
There are voices suggesting that if the Bank of Japan raises rates above 0.5%, “the Bank’s earnings may begin to deteriorate” (financial institutions).
According to Takahiko Wada, a researcher at Daiwa Institute of Research, the average nominal interest rate on the long-term government bonds held by the Bank of Japan, with a total balance of 579 trillion yen, is 0.57%. In contrast, the balance of current accounts, excluding required reserve balances, is about 536 trillion yen. If the interest rate paid on excess reserves at the Bank of Japan exceeds 0.62%, the amount of interest payments would exceed the interest income.
Governor Ueda has previously stated that necessary policies will not be hindered for the sake of the Bank of Japan’s finances, but if the Bank’s profitability begins to deteriorate, scrutiny in the National Diet is expected to intensify.
The U.S. presidential election and market trends also pose risks
In the background of the Bank of Japan’s decisions to raise rates in March and July, there was also moderate growth in overseas economies. However, the U.S. presidential election in November could influence the prospects for both the U.S. and Japanese economies, creating caution at the Bank of Japan.
There is also concern within the Bank of Japan that incremental rate hikes may create unforeseen distortions in the Japanese economy, prices, and markets. Following an extended period of deflation, incremental rate hikes have been absent for a long time, and it is a fact that there is no accumulation of various data. There are voices at the Bank of Japan stating that mistakes in the decision to raise rates are not permissible, and careful responses are necessary.
Nobuhide Kikuuchi, an executive economist at Nomura Research Institute (and former Bank of Japan policy board member), points out that due to the high uncertainty in economic and price trends, policy management going forward is “fluid.” He suggests that there might be one additional rate hike within the year and another early next year, with a final level approaching just below 1%. “If economic and price developments take a downturn due to instability in financial markets, it is highly likely that they will respond with quantitative policies such as increasing government bond purchases rather than restoring negative interest rates,” he states.
Takahiko Wada Editing: Hitoshi Ishida
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