Bank of Japan May Raise Rates by October if Tariff Uncertainty Eases

The former chief economist of the Bank of Japan has issued a warning that the central bank could potentially raise interest rates as early as October, provided that uncertainties surrounding tariffs dissipate. The economist highlighted that inflation in Japan is robust and has been a significant factor in the central bank's deliberations. The Bank of Japan's monetary policy committee, led by Governor Ueda, is expected to maintain the benchmark interest rate at 0.5% during its upcoming meeting, aligning with market expectations. However, the economist suggested that the central bank might act sooner than the market consensus, particularly if progress is made in U.S.-Japan tariff negotiations.

The committee faces a challenging task: balancing the need to reflect the current strong inflation trends in its quarterly economic outlook, scheduled for release on July 31, without abruptly altering market expectations. The economist predicted that the Bank of Japan will not only raise its inflation forecast for the current fiscal year but also for the next year. Recent data indicates that companies are transitioning from temporary cost-passing strategies to more sustainable price transmission mechanisms.

The economist noted that if the central bank raises its inflation forecast for the next year to 2%, the market might interpret this as a signal for an interest rate hike. Therefore, the central bank is likely to keep the figure below 2% to avoid such interpretations. In the May outlook report, the Bank of Japan projected that the core CPI would rise by 2.2% for the current fiscal year but only 1.7% for the next year, a trend that has supported the bank's cautious stance.

Despite the Bank of Japan's vigilance about rising prices, inflation has become a central issue in the upcoming parliamentary elections. The ruling and opposition parties are engaged in heated debates over whether to implement cash handouts or tax cuts. The central bank's latest quarterly survey revealed that Japanese households perceive an annual price increase of 20%, the highest on record.

The economist suggested that while the focus on combating inflation has primarily been on the government, there will eventually be calls for the central bank to take action. Governor Ueda has recently reiterated the need for caution, citing high uncertainty and the fact that potential inflation has not yet been realized. The economist, who has known Ueda for over four decades, acknowledged that the governor is aware of the risks involved in raising interest rates, particularly if the economy deteriorates due to tariff issues.

The economist concluded that from an inflation perspective, an earlier rate hike would be beneficial. However, given the high level of economic uncertainty, the Bank of Japan, and particularly Governor Ueda, must exercise restraint. The central bank is navigating a delicate balance between monetary policy and economic considerations, aiming to maintain stability amidst fluctuating conditions.