Bank of Japan Likely to Raise Interest Rates

By Leika Kihara

TOKYO (Reuters) – The Bank of Japan is expected to raise interest rates on Friday unless there are any surprises in the market with U.S. President-elect Donald Trump taking office. This move would increase short-term borrowing costs to levels not seen since the 2008 global financial crisis.

A tightening of policy would demonstrate the central bank’s commitment to gradually increase interest rates from the current 0.25% to near 1%, a level that analysts believe will neither cool nor overheat Japan’s economy.

At the two-day meeting concluding on Friday, the BOJ is likely to raise its short-term policy rate to 0.5% unless Trump’s inaugural speech and executive orders disrupt financial markets, sources revealed to Reuters.

In its quarterly outlook report, the board is also expected to raise price forecasts, as increasing wage gains improve the chances of Japan sustainably achieving the bank’s 2% inflation target.

This hike by the BOJ would mark the first since July last year, which had resulted in a market rout due to weak U.S. jobs data. To prevent a repeat of such a reaction, the BOJ has been cautiously preparing the markets through clear signals from Governor Kazuo Ueda and his deputy last week, leading to a rebound in the yen and an approximate 80% market expectation of a rate increase.

Last month, while the BOJ refrained from raising rates during the Dec. 18-19 meeting, hawkish board member Naoki Tamura suggested an adjustment, with other colleagues agreeing that conditions were ripe for a potential hike, as per the meeting minutes.

As a policy tightening this week appears almost certain, market attention will shift to Ueda’s post-meeting briefing for indications on the timing and pace of future increases.

With inflation consistently above the BOJ’s 2% goal and the weakened yen driving up import costs, Ueda will likely reaffirm the policymakers’ commitment to continue raising interest rates. However, caution is advised, as Trump’s policies could destabilize markets and create uncertainty for Japan’s export-dependent economy.

Domestic political instability might increase as well, with Prime Minister Shigeru Ishiba’s minority coalition facing challenges in passing a budget through parliament and an upcoming upper house election in July.

Past unsuccessful rate hikes still linger in the memories of BOJ policymakers. In 2006, the BOJ ended quantitative easing and raised short-term rates to 0.5% in 2007, actions that triggered significant political backlash for delaying an end to deflation.

Following the global financial crisis, the BOJ cut rates from 0.5% to 0.3% in October 2008, and then to 0.1% in December of that year, as Japan descended into recession. Since then, various unconventional measures have kept borrowing costs near zero.

Jeffrey Young, CEO of DeepMacro, noted, “Japan had a permanently low growth rate, inflation rate, and lower level of interest rates. So policymakers, investors, and the business community still ask – have we really broken free from that?” He added that the BOJ must carefully explain that rate increases aim to transition away from the extraordinary policies previously adopted.