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BOJ downplays weak yen impact, but keeps door open for rate hikes

Bank of Japan chief Kazuo Ueda on Friday played down the immediate impact of the yen's recent sharp decline on prices, calling it negligible, but said the central bank will raise interest rates again if inflation accelerates further. The BOJ's new forecasts released after a two-day policy meeting show Japan's inflation will likely be around its target of 2 percent until the end of fiscal 2026, accompanied by a positive cycle of wage and price hikes. The BOJ maintained its policy rate and bond-buying, which along with Ueda's comments weakened the yen further beyond the 156 line against the U.S. dollar, its lowest level since 1990. Its fall fueled fears of market intervention by Japanese authorities. The central bank decided to guide short-term interest rates in a range of zero to 0.1 percent and vowed to continue buying the same amount of Japanese government bonds at a rate of around 6 trillion yen ($38 billion) a month. Bank of Japan chief Kazuo Ueda speaks at a press conference in Tokyo on April 26, 2024. (Kyodo) The Policy Board has "judged that the impact of the weaker yen on trend inflation has not been big," but "we cannot rule out the risk of it materializing as zero," Ueda told a post-meeting press conference. Ueda reiterated that the BOJ will consider a policy response if the yen's impact is too big to ignore. For now, financial conditions should remain "accommodative" as trend inflation, which strips away one-off factors, is slightly below 2 percent, he said. "Going forward, if trend inflation accelerates toward 2 percent according to our forecast, we will raise the policy rate and adjust the degree of monetary easing," the governor said. In a newly released report, the BOJ upgraded its inflation outlook for fiscal 2024 and 2025. Core consumer prices, excluding fresh food, are now forecast to rise 2.8 percent, rather than 2.4 percent, in the year to next March, and then 1.9 percent, instead of 1.8 percent, the following year. The key gauge of inflation is forecast to increase by 1.9 percent in fiscal 2026, the final year of the latest forecast period. As a positive cycle of wage growth and price hikes intensifies, the BOJ said inflation will be "at a level that is generally consistent" with its 2 percent target toward the end of fiscal 2026. The BOJ is looking to see whether wages will grow as indicated by the strong outcome of spring pay negotiations between management and labor unions, service price inflation, and the effects of the weaker yen and rising crude oil prices on prices more broadly, Ueda said. Japan saw inflation accelerate in recent years, driven by higher import prices of energy and raw materials amplified by the yen's weakness. The bout of cost-push inflation prompted Japanese firms to raise wages to help consumers cope with the rising prices of everyday goods. Asked about the impact of the yen's renewed weakness on the price outlook, Ueda said the effect of higher import costs may not be as big as that seen between 2021 and 2022 when they surged. "We need to be careful about the risk of the impact on prices growing" if people's expectations on the price and wage outlooks are changing, Ueda said. "Overall, the BOJ was actually less hawkish than market expectations," said Shunsuke Kobayashi, chief economist at Mizuho Securities, adding that Ueda "surprisingly" distanced himself from foreign exchange-related issues at the press conference. The BOJ may be in a "deadlock" because it wants to prevent the yen from falling further but cannot raise interest rates aggressively, he said, expecting the policy rate will be hiked to 0.25 percent in October and then to 0.5 percent next year. The interest rate gap between Japan and the United States is wide as the Federal Reserve guides its policy rate between 5.25 percent and 5.5 percent and a string of forecast-beating strong data reduces expectations that it will lower the rate soon. Takahide Kiuchi, a former BOJ board member, said the BOJ is looking beyond the initial, transitory cost-push inflation that may come with the weaker yen, saying that it will take "a reasonable amount of time" for wage hikes to follow and push up underlying inflation. It is still possible for the BOJ to move up the timing of the next rate hike to counter yen weakness, according to Kiuchi, now executive economist at the Nomura Research Institute. But he expects the next increase will come in September to ensure wage growth and service price inflation. The price of services tends to rise more slowly than those of goods, which are susceptible to swings in energy and raw material prices. When service providers decide to raise prices, they do so to reflect increased labor costs. In March, the central bank ended the negative interest rate and loosened its control over long-term bond yields, major pillars of unorthodox policy measures to beat deflation. But it has not gone as far as to stop its bond buying for fear of sending yields surging and hurting the economy. The BOJ has signaled that it plans to reduce its buying at an appropriate time, which would eventually help trim its bloated balance sheet, a process known as quantitative tightening. Related coverage: Japan ready to take necessary steps on yen movements: finance chief Dollar at 34-yr. highs in upper 155 yen as intervention line tested BOJ to check effects of rate hike amid weak yen at policy meeting