Trade tension alleviation could prompt interest rate hikes according to minutes from the Bank of Japan's June meeting.
Bank of Japan Signals Gradual Interest Rate Hikes Amid Inflation Pressures
The Bank of Japan (BoJ) has signaled its readiness to gradually increase interest rates, despite some uncertainties and concerns over global trade policies and food price volatility. This shift comes as the BoJ raised its inflation forecast for fiscal 2025 to 2.7%, reflecting persistent increases in food prices and stronger-than-expected inflation pressures.
At its latest meeting on July 30-31, the BoJ kept its benchmark interest rate steady at 0.5%, marking the highest level in 17 years. However, the central bank has indicated a possible rate hike by the end of 2025 or early 2026, with economists widely expecting at least a 25 basis point increase.
One of the key factors driving this shift is the emergence of home-made inflation, as seen in rising wages due to labor shortages. Some members of the BoJ are paying close attention to this trend, as it could signal a more sustained period of inflation.
However, the BoJ has also expressed caution, highlighting uncertainties related to global trade policy impacts, including U.S. tariffs, and food price volatility. The central bank's inflation outlook anticipates easing inflation to around 2% by fiscal year 2026 and 2027 as transient price rises, like those for rice and food, wane.
In addition to interest rate increases, the BoJ has also decided to decelerate the pace of its balance sheet drawdown next year. In deciding on next year's bond taper plan, some members of the BoJ see the need to scrutinize the desirable size of the BOJ's balance sheet in the long run.
Meanwhile, the recently enacted trade deal with the U.S. may soften some risks or pull forward tightening if it leads to stronger growth or inflation. However, the BoJ continues to assess these trade effects cautiously before acting.
The remarks from the BoJ members highlight the board's growing attention to upside inflation risks. In an extended taper plan decided in June, the BOJ expects monthly purchases to fall to around 2 trillion yen by March 2027. The central bank is currently tapering bond buying so that monthly purchases slow to around 3 trillion yen by March 2026.
Despite these moves, some members of the BoJ believe the impact of U.S. tariffs on corporate earnings may be smaller than initially expected. Others suggest that a cut to around 1 trillion yen in monthly bond buying would suffice.
However, some members of the BoJ also stress the need for caution, stating that they would likely pause rate hikes for the time being due to high uncertainties. Others see scope to resume interest rate increases once trade friction caused by U.S. tariffs eases.
In summary, the BoJ has kept interest rates steady for now but has raised inflation forecasts and signaled readiness to increase rates gradually, likely starting later in 2025 or early 2026, depending on inflation trends and trade deal impacts with the U.S. The central bank's cautious approach reflects its efforts to navigate the complex and uncertain global economic landscape.
The Bank of Japan's economic outlook includes an anticipated increase in interest rates, partly due to the bank's efforts to manage home-made inflation and stronger-than-expected inflation pressures. This shift in the finance sector, as seen in the BoJ's decisions, is also influenced by the business environment, including global trade policies and food price volatility.
