The Bank of Japan (BOJ) is contemplating a potential interest rate hike if the yen's depreciation significantly impacts inflation, according to board member Seiji Adachi. In a speech delivered on Wednesday, Adachi outlined the circumstances under which the central bank might adjust its monetary policy sooner than anticipated.
Adachi emphasized that short-term currency fluctuations alone would not trigger a policy shift. However, a persistent and sharp decline in the yen, leading to heightened inflation expectations, could necessitate an earlier rate increase. "We must by all means avoid raising interest rates prematurely. But by focusing too much on downside risks, we could see inflation accelerate in a way that forces us to tighten monetary policy sharply later on," Adachi remarked during his address to business leaders in Kumamoto, southern Japan.
The BOJ's cautious approach to rate hikes highlights the delicate balance it must maintain between supporting economic growth and controlling inflation. Adachi underscored the importance of considering both downside and upside risks in guiding policy. "As long as underlying inflation continues to head toward 2%, it's important to gradually adjust the degree of monetary support reflecting economic, price, and financial developments," he added, signaling a possible near-term rate hike.
The yen's depreciation has been a significant concern for Japanese policymakers. The currency has weakened by approximately 10% against the dollar this year, despite the BOJ's decision in March to end eight years of negative interest rates. This divergence between U.S. and Japanese interest rates has been a critical factor driving the yen's decline. On Wednesday, the yen fell to its weakest level in four weeks against the dollar, with the currency pair trading at 157.10 yen per dollar.
Adachi projected that consumer inflation would re-accelerate from the summer through autumn due to rising import costs and sustained wage gains. "If yen falls accelerate or persist, consumer inflation may rebound sooner than expected. If this happens at a time when there is a higher chance of inflation durably and stably exceeding 2%, we may need to push forward the timing of an interest rate hike," Adachi said.
The potential rate hike could come as early as July, according to some analysts. The prospect of a near-term increase has already influenced market expectations, pushing Japan's 10-year government bond yield to 1.07% on Wednesday, its highest level since December 2011. Traders are also speculating on the possibility of the BOJ reducing its bond purchases next month, following an unscheduled cut in bond buying on May 13.
Despite these speculations, Adachi clarified that the BOJ's reduction in bond buying earlier this year had no policy implications and that the central bank would proceed cautiously with any future tapering. "Any reduction in bond purchases will be done in several stages to avoid destabilizing markets," he said, noting that the BOJ had no pre-set schedule for tapering.
The BOJ's focus remains on achieving its 2% inflation target sustainably. Governor Kazuo Ueda has indicated that the central bank intends to hike rates to levels considered neutral to the economy, provided growth and inflation align with projections. Ueda has also stated that the BOJ will eventually scale back its bond purchases and reduce the size of its balance sheet.
Japan's economic outlook has been mixed, with consumer sentiment worsening for the second consecutive month in May as rising prices impacted households. The government revised its assessment of consumer sentiment, noting that improvements were stalling. This context underscores the challenges facing the BOJ as it navigates its monetary policy amid fluctuating economic indicators and currency movements.
