The Bank of Japan may raise interest rates gradually as rising inflation expectations leave more room to normalize its ultra-loose monetary policy, the International Monetary Fund said on Friday.
The speed of future rate hikes will be “very data-dependent” as the BOJ watches the pace at which inflation, wage growth and inflation expectations rise during policy normalization, said IMF chief economist Pierre-Olivier Gourinchas.
Gourinchas said Japan’s inflation is above 2 percent and inflation expectations have started to approach, or “maybe even a little above,” the BOJ’s 2 percent target.
As a result, the BOJ is normalizing the ultra-loose monetary policy it has had for decades, which “we certainly think is a good development for Japan,” he told Reuters in an interview on the sidelines of the annual economic symposium in Jackson Hole, Wyoming.
“Certainly, in our assessment, there is scope for further normalisation of monetary policy going forward, and for interest rates to rise gradually over some time,” he said.
The BOJ ended negative interest rates in March and raised its short-term policy rate to 0.25 percent in July, in historic steps away from a decade-long sweeping stimulus program.
BOJ Governor Kazuo Ueda has signaled the bank’s willingness to continue raising interest rates if inflation moves toward meeting its 2 percent target for the long term, as he expects.
While Japan’s economic growth is set to slow in 2024 from last year’s fiscal stimulus-fueled expansion, the focus for the BOJ is not just on economic activity but on inflation, Gourinchas said.
Unlike other central banks that focused on controlling inflation expectations, the BOJ had to pull them back from decades of excessively low levels, he said.
“What the BOJ is trying to engineer is a realignment of inflation expectations,” Gourinchas said.
“We expect that as inflation expectations remain stable at their new level of around 2 percent, the BOJ will start to normalize policy rates,” he said.
The BOJ’s surprise rate hike in July and Ueda’s hawkish signal rattled financial markets in August, forcing his deputy to offer dovish assurances that there would be no hikes until markets stabilized.
Speaking in parliament on Friday, Governor Ueda reaffirmed the BOJ’s willingness to continue raising rates, but with particular attention to the economic fallout from still-unstable markets.
Gourinchas said the recent market turmoil was due to a combination of factors, including the prospect of higher Japanese interest rates and weak U.S. jobs data that fueled expectations of faster-than-expected rate cuts by the Federal Reserve.
The weak trading activity during the August holiday season, coupled with a massive sell-off in the yen carry trade, also increased market volatility, he said.
“I think the market overreacted,” he said. “I think a lot of this has been resolved, but we could see another bout of volatility in the market as markets are… in a bit of uncharted territory” with many central banks beginning to ease monetary policy while the Bank of Japan starts to raise rates, he said.
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