To what extent can the Bank of Japan raise interest rates?

According to the Zhitong Finance APP, the Bank of Japan is preparing for another interest rate hike, but the market is still speculating on how quickly it will raise the currently low borrowing costs. Here is the recent communication from the Bank of Japan regarding the possible timing and extent of future interest rate hikes.

What has the Bank of Japan said and done so far?

The Bank of Japan ended its eight-year negative interest rate policy in March this year and unexpectedly raised the policy interest rate by 15 basis points to 0.15%-0.25% in July. Bank of Japan Governor Kazuo Ueda stated on Monday that the economy is moving towards sustained wage-driven inflation. This statement has been interpreted as the latest signal that interest rate hikes are on the horizon again.

Ueda also discussed the benefits of timely interest rate hikes, stating that raising borrowing costs from extremely low levels would help achieve long-term economic growth. This wording is similar to what the Bank of Japan used during its last interest rate hike cycle in 2007.

At that time, former Bank of Japan Governor Toshihiko Fukui stated that an early and gradual exit from stimulus measures would help prevent bubbles and achieve stable, sustainable economic growth. Under Fukui's leadership, the Bank of Japan raised rates from zero to 0.5% in February 2007 through two rate hikes. However, the following year, in response to the global financial crisis, the Bank of Japan was forced to re-enter a rate-cutting cycle and kept rates near zero for the next 16 years.

When will the Bank of Japan's next interest rate hike occur?

Ueda believes that wages will continue to rise and stimulate consumption, allowing companies to continue raising prices, which will meet the prerequisites for further interest rate hikes. Although Ueda warned of uncertainties and market volatility stemming from the U.S. economy, he indicated that the Bank of Japan does not necessarily have to wait for all these risks to dissipate, suggesting he is open to another rate hike at the December policy meeting.

Bank of Japan policymakers have not committed to a preset timeline for the next interest rate hike. However, they believe that the market's expectation for the Bank of Japan to raise the policy rate to 0.5% by the end of March next year is reasonable.

Where does the Bank of Japan see the neutral interest rate?

If the Japanese economy continues to recover, the Bank of Japan will continue to raise its short-term policy interest rate, bringing it closer to Japan's neutral interest rate, which neither stimulates nor suppresses economic growth.

The Bank of Japan currently maintains the short-term policy interest rate at 0.25%. However, Japan's inflation rate has hovered around 2% for more than two years, meaning that the real borrowing costs, adjusted for inflation, remain very low. By raising borrowing costs to what is considered neutral for the economy, the Bank of Japan can exit what it sees as excessive monetary stimulus.

However, estimating the neutral interest rate is not easy, as different models yield different results. Bank of Japan staff have estimated that Japan's inflation-adjusted real neutral interest rate is around -% to 0.5%. This means that if the inflation rate reaches the Bank of Japan's target of 2%, the Bank of Japan could raise short-term rates to around 1% without causing a slowdown in economic growth According to the October forecast, the Bank of Japan expects short-term interest rates to approach what it considers a neutral level in the "latter half of the three-year forecast period" ending in March 2027.

Although Bank of Japan board member Naoki Tamura stated in September that the central bank must raise rates to at least 1% by the end of next year at the earliest, his colleagues remain silent on the neutral interest rate level. Kazuo Ueda has also mentioned that it is difficult to make credible estimates due to a lack of data, as Japan's interest rates have long remained at zero levels.

What are the key trigger factors to note?

Setting aside the neutral interest rate, the movement of the yen will have a significant impact on the timing of the Bank of Japan's interest rate hikes. The weak yen was a factor that prompted the Bank of Japan to raise rates in July, as the weak yen increased import costs and broader inflation.

The uncertainty brought about by the economic policies that Donald Trump will implement after being elected President of the United States has also complicated the Bank of Japan's decisions. Many of Trump's policies are believed to lead to a resurgence of inflation and may prevent the Federal Reserve from significantly lowering interest rates, thereby keeping the yen weak against the dollar.

When might the Bank of Japan provide more hints?

Investors are closely watching the Japanese October CPI data to be released on November 22. They will look for clues on whether companies are passing on rising labor costs through higher service prices.

Moderate Bank of Japan board member Toyoaki Nakamura is cautious about raising rates too quickly and will give a speech and hold a press conference on December 5.

Additionally, the Bank of Japan will release its quarterly economic survey on December 13. If the data shows strengthening in corporate confidence, capital expenditure plans, and corporate inflation expectations, the likelihood of a rate hike in December may increase