IMF Indicates Potential for Bank of Japan to Continue Increasing Rates, According to Reuters

By Leika Kihara and Howard Schneider

JACKSON HOLE, Wyoming – The International Monetary Fund (IMF) stated on Friday that the Bank of Japan (BOJ) can gradually increase interest rates as inflation expectations continue to rise, providing more room to normalize its long-standing ultra-loose monetary policy.

The pace of any further rate increases will rely heavily on data, with the BOJ assessing the rate of inflation, wage growth, and inflation expectations as it moves towards policy normalization, explained IMF chief economist Pierre-Olivier Gourinchas.

Gourinchas noted that Japan’s inflation currently exceeds 2%, and inflation expectations have begun to approach, or potentially exceed, the BOJ’s target of 2%. Consequently, the BOJ is gradually moving away from its extremely loose monetary policy, which has been in place for decades, a development Gourinchas views positively for Japan’s economy.

In recent actions, the BOJ ended its negative interest rate policy in March and increased its short-term policy rate to 0.25% in July, marking significant steps away from a decade of radical stimulus measures. BOJ Governor Kazuo Ueda has indicated the bank’s willingness to continue raising interest rates if inflation trends toward sustainably meeting its 2% target.

Looking ahead, while Japan’s economic growth is anticipated to slow in 2024 following last year’s fiscal stimulus, Gourinchas emphasized that the BOJ will prioritize inflation levels over mere economic activity.

In contrast to other central banks that have worked to contain inflation expectations, the BOJ’s challenge has been to raise them from prolonged periods of low levels. "What the BOJ is trying to engineer is a realignment of inflation expectations," said Gourinchas, forecasting that stable inflation expectations close to 2% would lead to further normalization of policy rates.

The BOJ’s unexpected rate hike in July and Ueda’s hawkish stance led to market upheaval in August, prompting reassurances from his deputy that no further hikes would occur until market stability returns. Speaking in parliament, Ueda reiterated the institution’s readiness to increase rates while closely monitoring the economic repercussions of current market volatility.

Gourinchas attributed the recent market fluctuations to a combination of factors, including expectations of rising Japanese interest rates and disappointing U.S. employment data that raised speculation about quicker-than-expected rate cuts by the Federal Reserve.

He also noted that thin trading during the August holiday season, along with a significant unwinding of the yen carry trade, contributed to heightened market instability. "I think the market overreacted," he remarked, adding that while many issues have since been resolved, further episodes of market volatility could arise as different central banks ease their policies, while the BOJ begins to increase rates.