Now that Japan increased interest rates for the first time since 2007, investors and economists are divided over how long it will take before the central bank opts for another hike.

Bank of Japan watchers agree that it will not aggressively raise rates at the pace the US Federal Reserve moved when it was battling inflation. But the consensus on how far the BOJ will go largely breaks down after that – and BOJ governor Kazuo Ueda provided enough ammunition for both sides of the argument in a carefully hedged press briefing on March 19 after ending Japan’s eight-year experiment with negative rates. 

Currency traders focused primarily on Mr Ueda and the BOJ’s insistence that easy financial conditions will stay in place for now. That stance helped weaken the yen by more than 1 per cent beyond the 150 mark against the dollar, as some market participants concluded the BOJ will sit on its new 0 per cent to 0.1 per cent rate for the rest of the year, particularly as the economy looks weak.

Analysts surveyed by Bloomberg are forecasting the BOJ’s policy target rate at 0.1 per cent at the end of 2024, indicating a majority does not expect another rate hike as a base case. But plenty of others are warning that the BOJ may not be finished. 

By moving in March instead of the long-held consensus view of April, Mr Ueda secured more space to raise borrowing costs again in 2024 if data supports the case. The governor repeatedly said on March 19 that real interest rates in Japan remain deeply negative, and renewed weakness in the yen may also spark concern among government officials seeking more action to firm up the currency.   

Looking at Japan’s real interest rates suggests there is plenty of scope for moving upward while keeping conditions easy. Economists estimate that inflation in February was 2.9 per cent, a level that would put the latest real rate at minus 2.8 per cent. The BOJ’s price target is 2 per cent, a goal Mr Ueda said on March 19 has “come within view”.

While economists polled by Bloomberg have cited 0.5 per cent as the likely terminal rate of the BOJ’s hiking cycle, the spread of opinions is very wide: Sony Financial Group’s Masaaki Kanno is eyeing 2 per cent, for instance, while Itochu Research Institute’s Atsushi Takeda has pencilled in 2.5 per cent.

Mr Ueda acknowledged on March 19 that it was not easy to determine the ideal interest rate for the economy. He flagged the difficulty of calculating both the neutral rate and agreeing on all the inputs for the Taylor Rule, a formula for central banks to set rates at an optimal level to stabilise economic activity. Mr Ueda has cited the rule on occasion in the past to explain his views on interest rates. 

“Given all the numbers you plug in and the different parameters and the way you apply them, you end up with a large variety of interest rate levels,” Mr Ueda said, indicating he was against any mechanical application of a rule that produced a range of results.

Those predicting a hike point to Rengo, a federation of unions, which showed that its members have so far secured deals averaging 5.28 per cent, the biggest in more than 30 years. Those numbers triggered a recalibration of views among economists toward a likely March move by the BOJ and the chance of inflation building momentum.

BNP Paribas economist Ryutaro Kono flagged the risk of faster rate hikes if higher wages fuel upward movement in prices.

“In that case, rates would top 1 per cent by the end of 2025,” Mr Kono wrote in a note on March 19. “Also, depending on the exchange rate and how personnel costs are passed on to prices after April, there’s a risk of the second rate hike being brought forward to July.”

The counterargument is that economic growth remains lacklustre, inflation is decelerating and other major central banks are about to start cutting rates. 

“This is a one and done,” said Ms Tuuli McCully, senior economist at the Bank of Finland Institute for Emerging Economies. “They had to act now, because even a month from now they may have lost the opportunity to normalise things.”

While the talk of continuing easy conditions reinforced that view among some economists, others flagged the need to look at what Mr Ueda has done rather than his dovish messaging. 

When Mr Ueda took over in April 2023, his initial comments suggested he was far more aligned with previous governor Haruhiko Kuroda’s thinking and would move much more slowly to tighten policy. Ultimately, though, his desire for a monetary framework with greater textbook orthodoxy seems to have prompted him to surprise BOJ watchers in moving quickly to dismantle the biggest monetary stimulus experiment in post-World War II history.

‘Nerves of steel’

Investors may need to be prepared for a similar pattern playing out. Mr Ueda emphasised on March 19 the need to keep conditions easy for the economy for now, while also flagging that an increase in the upward risks to prices would warrant another rate hike.

Mr Hideo Kumano, economist at Dai-ichi Life Research Institute, expects another hike due to inflationary pressures such as wage hikes at smaller companies, a rise in oil prices and the end of government price relief measures. He also pointed to Mr Ueda’s resolve in following through with the BOJ’s hike ahead of the April consensus timing after checking wage data released as recently as March 15.

“He made such a big decision within just a few days of the strong spring wage results,” said Mr Kumano, who expects the next hike to come in October or December. “You can’t do something like that unless you have nerves of steel.” BLOOMBERG