By Leika Kihara
TOKYO (Reuters) – After clearly signaling the interest rate hike last week, the Bank of Japan could return to its usual fuzzy forecast on central bank policy to maintain flexibility as it ultimately considers how much tightening is enough.
The BOJ fudged its communication in December and surprised investors when it left interest rates steady, but then announced the hike on Friday so clearly that markets had priced it in at 90% and took the move in stride.
This shift to clearer guidance, an approach the Federal Reserve used to signal a policy shift in August, could prove temporary. Japan’s policymakers are afraid to be guided by markets and are uncertain about the extent to which the BOJ can raise interest rates without cooling growth, analysts and people familiar with the central bank’s thinking say.
Policymakers are frightened by the feeling that they need to give clear signals before each meeting given the uncertain economic outlook, and they lack conviction in the Goldilocks “neutral” interest rate that neither chills nor overheats the economy.
After the BOJ surprised markets with its December decision, Gov. Kazuo Ueda cited uncertainty over U.S. economic policy ahead of Donald Trump’s return as president as the main reason it refrained from raising interest rates.
Ueda’s comments were seen as dovish and pushed market prices for the action down from 70% to 46% in January.
To avoid shaking markets again, the BOJ then laid the groundwork for January’s rate hike, taking its cue from Fed Chairman Jerome Powell, who had explicitly signaled impending change by proclaiming that “the time for an adjustment in policy has come.”
COST OF CLARITY
Ueda and his deputy, Ryozo Himino, each said the week before Friday’s hike that the BOJ board would “debate raising interest rates” – effectively announcing its decision to double short-term interest rates to 0.5% .
“Without these comments, a rate hike in January would have been a big surprise,” said Naomi Muguruma, chief bond strategist at Mitsubishi UFJ (NYSE:) Morgan Stanley (NYSE:) Securities. “The BOJ probably had no choice.”
Asked about the warnings, Ueda said after Friday’s decision that they were merely a “reminder” that the board would discuss the feasibility of changing the policy at any tariff review.
But while the strategy allowed the BOJ to smoothly raise its key interest rate to its highest level in 17 years, it is not without costs.
Analysts say markets may be focusing too much on BOJ comments instead of looking at economic and price data to gauge the bank’s next interest rate hike.
Giving explicit advance signals could not only make the BOJ feel constrained but also violate Japanese law, which requires the nine-member board to discuss and approve interest rate decisions at every policy meeting.
“That raises some alarm bells,” a former politician said of the BOJ’s rate hike announcement on Friday. “The market should serve as a guide for central banks on the development of the economy. But if this practice continues, the BOJ will see only a reflection of itself in the market.”
“GREATER VARIABILITY”
Another reason for the return to ambiguity is the uncertainty about the end point of the tightening.
BOJ officials estimate Japan’s nominal neutral interest rate to be between 1% and 2.5%. While this hasn’t been a factor so far with the key interest rate so low, two more increases would bring the key rate to the lower end of that range – a level that many analysts consider a neutral rate.
While Ueda signaled the bank’s determination to continue raising interest rates, he gave little indication Friday of the pace or timing of further rate hikes, saying it would be difficult to set Japan’s neutral interest rate in real time.
“Because the BOJ doesn’t know exactly where the neutral rate is, it would have to wait about six months after any increase to check the health of the economy,” said Izuru Kato, chief economist at Totan Research. “Only if you assume that the neutral interest rate is still a long way off would you raise interest rates again.”
Further complications loom as the BOJ considers further interest rate hikes, which could make it even harder to convince the public of the need to further increase borrowing costs.
The bank justified the increase on Friday with the prospect of sustained wage increases, but it is uncertain whether consumption can withstand the rising cost of living.
Trump’s threats of higher tariffs could weigh on Japan’s export-dependent economy and business sentiment.
“The BOJ’s hands are increasingly tied to the complex task of managing price pressures, reflation efforts and overall market expectations,” said Frederic Neumann, chief Asia economist at HSBC Bank, adding that the risks related to Trump’s policies cannot be dismissed out of hand.
“All of this leads to greater variability in the future development of key interest rates.”
