The IMF endorses the Bank of Japan’s gradual interest rate hikes as inflation expectations rise, signaling a shift from its ultra-loose monetary policy. BOJ Governor Ueda remains cautious amid market volatility.
Japan, Bollywood Fever: The International Monetary Fund (IMF) expressed support for the Bank of Japan’s (BOJ) gradual approach to raising interest rates, citing rising inflation expectations that provide room to continue normalizing its ultra-loose monetary policy.Â
Speaking on Friday, IMF Chief Economist Pierre-Olivier Gourinchas emphasized that the pace of further rate increases will be highly dependent on data, particularly the trajectory of inflation, wage growth, and inflation expectations.
Japan’s inflation currently exceeds 2%, with expectations beginning to align with or even slightly surpass the BOJ’s 2% target.
This shift has prompted the BOJ to move away from its long-standing ultra-loose monetary policy, a development that Gourinchas described as positive for Japan’s economic landscape.
“Certainly in our assessment, there is scope for further normalisation of monetary policy going forward, and policy rates to increase gradually for some time,” Gourinchas stated during an interview at the annual economic symposium in Jackson Hole, Wyoming.
The BOJ has already taken significant steps toward policy normalization, ending negative interest rates in March and raising its short-term policy rate to 0.25% in July.
These actions mark a departure from the decade-long radical stimulus program that has characterized Japan’s monetary policy.
BOJ Governor Kazuo Ueda has signaled the bank’s readiness to continue raising rates if inflation continues to progress toward a stable 2% target.
While Japan’s economic growth is expected to slow in 2024 following a fiscal stimulus-driven expansion, Gourinchas highlighted that the BOJ’s focus remains on stabilizing inflation rather than solely on economic activity.
Unlike other central banks that have aimed to curb high inflation expectations, the BOJ has faced the challenge of raising expectations after decades of persistently low inflation. “What the BOJ is trying to engineer is a realignment of inflation expectations,” Gourinchas explained, adding that stable inflation expectations near the 2% mark would likely prompt further policy normalization.
The BOJ’s unexpected rate increase in July, coupled with Ueda’s hawkish stance, led to financial market turbulence in August.
This prompted Deputy Governor Shinichi Uchida to reassure markets that no immediate rate hikes were planned until conditions stabilized.
Speaking in parliament on Friday, Governor Ueda reiterated the BOJ’s commitment to closely monitor the economic impact of its policy moves amid ongoing market volatility.
Gourinchas attributed the recent market instability to a combination of factors, including the prospects of higher Japanese interest rates, weak U.S. jobs data that fueled expectations of faster rate cuts by the Federal Reserve, and thin market trading during the August holiday season. Additionally, the unwinding of the yen carry trade further amplified market volatility.
“I think the market overreacted,” Gourinchas commented. “I think a lot of this has been resolved, but we could see other episodes of market volatility as markets are … in a little bit of an uncharted territory” with many central banks starting to ease policy while the BOJ begins to raise rates, he added.
As Japan navigates this complex economic environment, the BOJ’s cautious yet determined approach to interest rate hikes will continue to be closely watched by both domestic and international markets.
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