TOKYO, Dec 12 (Reuters) – The Bank of Japan will likely maintain a pledge next week to keep raising interest rates, but stress the pace of further hikes will depend on how the economy reacts to each increase, said three sources familiar with its thinking.
Markets have almost fully priced in the chance of a rate hike to 0.75% from 0.5% at the December 18-19 meeting, after Governor Kazuo Ueda essentially pre-announced such a move. Attention has shifted to how far the BOJ could raise rates before they reach a neutral level, which neither stimulates nor cools growth.
While the central bank may internally update its estimate on how far its policy rate is from levels deemed neutral, it will not use the estimate as a main communication tool on the future rate-hike path given the difficulty of coming up with a precise projection, the sources said.
Instead, the BOJ will explain that decisions on future rate hikes will be made looking at how past rate increases affect bank lending, corporate financing conditions and other economic activity, the sources said.
With inflation exceeding its 2% target for well over three years, however, Japan’s real borrowing costs remain deeply negative – a point the BOJ will likely stress next week to justify further rate increases, the sources said.
“Japan’s real interest rates are very low, allowing the BOJ to continue raising rates in several stages,” said one of the sources, a view echoed by two other sources. The sources spoke on condition of anonymity as they were not authorised to speak publicly.
Although much lower than that of many countries, a hike to 0.75% would bring the BOJ’s policy rate to levels unseen in three decades.
It would also bring the policy rate close to the bottom of the 1.0%-2.5% range of the BOJ’s current estimate on where the neutral rate could lie. As such, some market players have speculated the BOJ would not raise rates much further for fear of hurting the economy.
The central bank will seek to dispel such views by clarifying that while neutral rates are important guideposts in setting monetary policy, they would not be a decisive factor in deciding how soon to next raise rates, the sources said.
Instead, the BOJ will scrutinise the economic impact of each rate hike to gauge how close its policy rate is to levels deemed neutral, in deciding whether to take rates higher, they said.
While the BOJ’s staff will conduct internal updates on the neutral rate estimate based on latest data, any findings will unlikely be released until next year, they said.
Central banks use the neutral rate as a benchmark in setting policy. But it is not directly observable and hard to estimate as factors affecting it, like productivity, change over time.
BOJ board member Asahi Noguchi warned of the dangers of relying too much on neutral rate estimates, saying in a speech last month it was “almost impossible” to gauge the exact level.
“The most realistic approach to actual policy conduct is to set a certain benchmark as the range where the neutral interest rate is thought to lie … and raise rates incrementally over time while monitoring the impact this has on economic activity and prices,” he said.
Seisaku Kameda, the BOJ’s former top economist, said the central bank will likely become more cautious than before in raising rates as they approach levels deemed neutral.
“The BOJ will probably update its neutral rate estimates but won’t be able to produce any pinpoint projections,” said Kameda.
“The key message the BOJ must and will likely deliver upon raising rates to 0.75% is that monetary conditions will remain accommodative even after the move.”
(Reporting by Leika Kihara and Takahiko Wada; Editing by Sam Holmes)
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