By Leika Kihara

NAGOYA (Reuters) – Bank of Japan Governor Kazuo Ueda stated that the economy is progressing toward sustained, wages-driven inflation but provided limited indication on a potential interest rate hike next month.

Ueda reiterated the BOJ's willingness to raise borrowing costs if economic conditions align with forecasts, suggesting that domestic factors for another rate increase are developing. However, he cautioned about monitoring external risks, particularly uncertainties regarding the U.S. economy and the fluctuating financial markets.

> "The timing for when we'll adjust the degree of our monetary support will depend on the economic, price and financial outlook," Ueda mentioned in a speech on Monday.

The ambiguity around guidance led to a 0.4% increase in the dollar, reaching 154.77 yen, as traders reversed positions anticipating Ueda would signal a December rate hike. Markets currently suggest a 55% probability of a quarter-point increase to 0.5% during the BOJ's meeting on December 19, which reflects little change from before Ueda's comments.

A recent Reuters poll from October 3-11 revealed that a slim majority of economists expect the BOJ to refrain from further rate increases this year, although nearly 90% believe rates may rise by the end of March.

The BOJ discontinued negative interest rates in March and raised its short-term policy rate to 0.25% in July, reflecting its view that Japan is close to sustainably achieving its 2% inflation target.

Ueda noted increasing inflationary pressure from a weakening yen, which raises import costs, as a factor that contributed to the July rate hike. This has led many market participants to bet that yen fluctuations will influence the timing of the BOJ’s next rate hike.

BOJ HAS 'FREE HAND'

Monday's remarks were Ueda's first on monetary policy since Donald Trump's election victory on November 5. When questioned about Trump’s return to the White House, he asserted that clarity on his economic policies would take time.

> "If one were to assume the BOJ will lay the groundwork before raising rates, the chance of a December hike declined," said Toru Suehiro, chief economist at Daiwa Securities.
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> "But you could also say the BOJ simply left itself a free hand, as the bias of Ueda's remarks was toward more hikes."

Ueda expressed optimism that rising wages and strong profits are elevating consumption and capital expenditure, indicating that domestic conditions are favorable for a near-term rate hike.

In October, companies began raising prices not just for products but also for services, typically when they review pricing, signaling that inflation is being driven more by domestic demand and higher wages as opposed to skyrocketing raw material costs.

> "A positive cycle, in which rising income leads to higher spending, is gradually strengthening for both companies and households," Ueda conveyed to business leaders in Nagoya.

> "We expect wage-driven inflationary pressure to heighten as the economy continues to improve and companies keep hiking pay," he continued, emphasizing that the BOJ's focus will be monitoring the continuation of wage and price growth.

Additional considerations included the gradual expansion of global growth that could underpin Japan’s export-reliant economy. Ueda mentioned, "The chance of the U.S. economy achieving a soft-landing scenario appears to be increasing," during his address, pointing out the improvement in market sentiment due to easing concerns over the U.S. economic outlook.

However, the central bank must remain cautious of external risks amid the potential for renewed market volatility from geopolitical tensions.