Bank of Japan keeps rates steady, raises growth and inflation forecasts

[TOKYO] The Bank of Japan raised its growth estimate and maintained its hawkish inflation forecasts on Friday even as it kept interest rates steady, signalling its confidence a moderate recovery would justify raising still-low borrowing costs further.

In a sign of its caution over the inflationary effects of a weak yen, the central bank said the currency’s moves could prod firms to pass on rising import costs and push up underlying consumer prices - a key gauge determining its rate-hike timing.

Board member Hajime Takata also proposed raising rates for the second straight meeting, which found no other voices in support but highlighted the hawkish momentum within the central bank.

At a two-day meeting that ended on Friday, the BOJ maintained its key policy rate at 0.75 per cent in a widely expected decision after having just hiked the rate from 0.5 per cent in December.

In a quarterly outlook report, the BOJ raised its growth forecast for fiscal 2025 and 2026, and maintained its view the economy will remain on course for a moderate recovery.

It also revised up its core consumer inflation forecast for fiscal 2026 to 1.9 per cent from 1.8 per cent three months ago, adding that risks to the economic and price outlook were roughly balanced.

“The mechanism in which wages and prices rise moderately in tandem will be sustained, allowing for underlying inflation to continue rising moderately,” the BOJ said in the report.

Markets are focusing on Governor Kazuo Ueda’s post-meeting press conference for hints on when the BOJ might next raise rates, a decision complicated by a fresh bout of market volatility caused by Prime Minister Sanae Takaichi’s decision to call a snap election next month.

“After its hike in December, it is no surprise that the BOJ remained on hold today. However, the central bank’s outlook report hints at growing hawkishness, with officials revising up their growth forecasts for the coming year and, crucially, also nudging up their inflation expectations for the next couple of years,” said Fred Neumann, chief Asia economist at HSBC in Hong Kong.

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“Governor Ueda in his remarks will likely lean into a more hawkish direction, which may keep the next meetings ‘live’ for a further policy rate hike,” he said.

The BOJ painted a more optimistic view of the economy from three months ago, adding in the report that a positive cycle of income and expenditure will “gradually strengthen.”

It also said underlying inflation will continue to gradually increase, even as government steps to curb fuel bills weigh on broader consumer price growth.

“Exchange rate moves are more likely to affect prices than in the past. Attention must be paid to how currency moves affect underlying inflation through changes in the public’s perception on future price moves,” the report said, warning of the inflationary pressure emanating from a weak yen.

BOJ reaction to yield move in focus

Japan’s economy has weathered the hit from US tariffs and is likely to get a lift from Takaichi’s stimulus package focusing on steps to cushion the blow from rising living costs.

But the premier’s vow to strengthen her expansionary fiscal policy and suspend the 8 per cent sales tax on food has stoked fears of additional debt issuance, leading to the spike in bond yields, which could hurt the economy.

The central bank is thus caught between a need to keep yen bears at bay with hawkish communication, without triggering further rises in bond yields on expectations of hefty spending by Takaichi’s government.

The yield spike has drawn renewed attention to the BOJ’s quantitative tightening plan, under which it has been unwinding its years of massive stimulus by gradually slowing its bond buying at a set pace to reduce its huge balance sheet.

The BOJ has been tapering bond buying since 2024 under a pre-set, moderate pace. But it has said it could suspend this tapering or conduct emergency bond-buying operations to cope with extreme market stress.

Some analysts speculate the BOJ could tap these tools soon. But the central bank has set a high hurdle for deploying these measures, as ramping up bond-buying would run counter to its efforts to wean the economy off the stimulus it deployed to fight years of deflation.

Ueda has repeatedly said while bond yields should be set by markets, the BOJ will step in if they make “exceptional, unusual moves.”

The BOJ changed direction in 2024, raising its policy rate several times and tapering bond purchases on the view Japan was on the cusp of durably achieving the bank’s 2 per cent inflation target. REUTERS