With wages increasing, consumption and capital expenditure were also expanding, thus making it a good time for the Bank of Japan to increase its interest rate.
The Bank of Japan (BOJ) made history earlier this year by raising interest rates and ending its long-standing tradition of offering negative interest rates. It also raised its short-term borrowing costs in July to 0.25%. In the last couple of months, there has been much speculation over when and how much the interest rates would be raised again. However, while the hikes were always looming, there has been no confirmation regarding its implementation.
Economists had predicted that the interest rate would change by the end of March next year. The announcement of elections and the preparation of the fiscal budget for the following year also halted the Bank from implementing any changes.
Earlier this week, however, Bank of Japan Governor Kazuo Ueda said that the economy was progressing towards sustained wages-driven inflation. With this improvement, he warned against keeping borrowing costs too low. This signals yet another increase in interest rates. Ueda explained that in a bid to increase interest rates, the BOJ must gradually decrease stimulus, as keeping lowered interest rates for prolonged periods could bump up inflation more than expected.
The markets were waiting patiently for a statement from the Governor, as monetary policy was likely to be influenced due to major international events, particularly, the re-election of US President Donald Trump. He also explained that the BOJ was unlikely to wait out the external risks that the Trump tariffs could bring before raising the interest rates. The Governor explained that while there were a number of potential market uncertainties that could soon be unfolding, the Bank would make policy decisions based on the available data, rather than wait for the mitigation of these risks and subsequent consequences.
Ueda was positive that domestic progress in the form of wage increases should not only result in an increase in the price of commodities but also services. With wages increasing, consumption and capital expenditure were also expanding, thus making it a good time for the Bank to increase its interest rate.
Ueda is assured that as the economy improves, wage-driven inflationary pressure will also increase; and that the BOJ’s monetary policy will be centered around wages and prices will continue to rise. In October, Reuters reported that the Japanese economy had expanded at an annualised 2.9% in the second quarter. Capital expenditure was also projected to grow, despite diminishing demand in China and the overall stagnation of the US economy, which could be a hurdle for an export-heavy country such as Japan.
Ueda is confident that increasing the borrowing costs, which are extremely low to begin with, is healthy for the economy in the long run. Financial analysts believe that if the economy continues in its recovery phase, the BOJ will keep raising the short-term policy rate towards a neutral interest rate. Presently, the short-term rates are at 0.25% despite inflation being around 2% for the past couple of years. This means that when adjusted to inflation, the borrowing cost of the BOJ has been very low these past years.
The uncertainties over the interest hike had caused the value of the Yen to sink, recording ¥ 150 against the US dollar. Investors were also leaning towards the possibility that interest rates would be increased at a much slower pace, causing the Yen value to drop by 5% in October.
Due to such a phenomenon, policymakers have called for the BOJ to consider the market volatility while making any changes, as even the slightest increase can disrupt an already fragile market. The BOJ releases its quarterly business survey every December. If the data indicates inflation, strengthening business moods, and expansion of capital expenditure, the chance of an increase in interest rates is assured.