By Leika Kihara
TOKYO (Reuters) – As the guessing game over the timing of Japan’s next interest rate hike heats up, another debate is brewing within the central bank over just how much higher rates can go, a question that could be discussed at this week’s policy meeting.
While markets expect the Bank of Japan to hold off on raising rates on Thursday, Governor Kazuo Ueda is likely to elaborate on the bank’s thinking over the future rate-hike path.
BOJ staff estimates have shown the bank sees scope to hike short-term rates at least to around 1% without cooling growth, though some in the bank point to recent lacklustre consumption as a sign the level could be lower.
The outcome of the debate will be crucial in setting the pace of future interest rate hikes, as the BOJ eyes pushing up its policy rate to levels near neutral by around early 2027.
Most analysts expect the BOJ to raise short-term rates from the current 0.25% sometime by March, which will be an initial step towards hiking to levels deemed neutral to the economy.
Former BOJ board member Takahide Kiuchi expects the bank to slow the pace of rate hikes once it lifts them to 0.5%, as further increases will bring borrowing costs closer to neutral.
“The BOJ probably believes Japan’s neutral rate is slightly below 1%,” said Kiuchi, who projects the bank to hike rates to 0.5% in January and 0.75% around September next year. “Once rates move up to 0.5%, it will thus take a more empirical approach that closely assesses the economic impact of each rate hike.”
TREADING CAREFULLY
The BOJ exited a decade-long radical stimulus programme in March and raised short-term rates to 0.25% in July on the view Japan was on the cusp of sustainably achieving its 2% inflation target.
Ueda has said the BOJ will hike to near Japan’s neutral rate – or the level at which monetary policy is neither contractionary nor expansionary – if the economy keeps recovering.
The BOJ has produced staff estimates that show Japan’s inflation-adjusted real neutral interest rate to be in a range of around -1% to +0.5%. That means if inflation were to hit 2%, the BOJ can hike rates at least to around 1% without cooling growth.
Based on current forecasts made in October, the BOJ expects short-term rates to approach what it considers neutral “in the latter half of the three-year projection period” through March 2027, which suggests some time after October 2025.
But there is no consensus within the BOJ on where precisely the neutral rate is, due partly to a lack of credible estimates in a country where interest rates had been stuck around zero for more than two decades.