IMF sees possibility that Bank of Japan will continue to raise interest rates By Reuters

By Leica Kihara and Howard Schneider

JACKSON HOLE, Wyoming (Reuters) – The Bank of Japan may gradually raise interest rates as rising inflation expectations leave additional room to normalize its ultra-loose monetary policy, the International Monetary Fund said on Friday.

The pace of further rate hikes will be “highly data-dependent” as the BOJ looks at the pace at which inflation, wage growth and inflationary expectations rise in normalization policy, IMF chief economist Pierre-Olivier Gourinchas said.

Gourinchas said Japan’s inflation is above 2 percent and inflationary expectations have started to move towards, or “maybe even slightly above” the BOJ’s 2 percent target.

As a result, the BOJ is normalizing the extremely loose monetary policy it has had for decades, which is “certainly something we think is a good development for Japan,” he told Reuters in an interview at sidelines of the annual economic symposium in Jackson Hole, Wyoming.

“Certainly, in our assessment, there is room for further normalization of monetary policy going forward, and policy rates will gradually increase over a period of time,” he said.

The BOJ ended negative interest rates in March and raised its short-term policy rate to 0.25 percent in July, a major step back from a decade-long radical stimulus program.

BOJ Governor Kazuo Ueda has signaled the bank’s willingness to continue raising interest rates if inflation makes progress toward a sustainable 2 percent target, as expected.

While Japan’s economic growth will slow in 2024 as a result of last year’s fiscal stimulus-driven expansion, what is important to the BOJ is not just economic activity but also inflation, Gourinchas said.

Unlike other central banks that have focused on taming inflationary expectations, the BOJ has had to raise them from decades of too-low levels, he said.

“What the BOJ is trying to create is a realignment of inflationary expectations,” Gourinchas said.

“We expect that as inflation expectations remain stable at their new level of close to 2 percent, the BOJ will begin to normalize policy rates,” he said.

The BOJ’s surprise July interest rate hike and Ueda’s bullish signal rattled financial markets in August, forcing his deputy to offer conciliatory assurances that there would be no hikes until markets stabilized.

Speaking in parliament on Friday, Governor Ueda reaffirmed the BOJ’s willingness to continue raising rates, but with a careful eye on the economic fallout from still volatile markets.

Gourinchas said the recent market turmoil was due to a mix of factors, including the prospect of higher Japanese interest rates and weak US jobs data, which fueled expectations of faster-than-expected cuts by the Reserve Federal.

Thin market trading during the August holiday season, along with a massive recovery in yen trading, also increased market volatility, he said.

“I think the market has overreacted,” he said. “I think a lot of that has been resolved, but we could see some more episodes of market volatility because the markets are … in a little bit of uncharted territory,” many central banks starting to ease policy, while the BOJ start raising rates, he said.