Interest rates appear to be back on track in Japan for good; Bank of Japan Governor Ueda suggests past cautious approach is over

After years of ultra-low interest rates, Japan appears to be returning to a “world of interest rates.”

The Bank of Japan decided Wednesday at a monetary policy meeting to raise its short-term interest rate target to around 0.25%, the second such increase this year. At a news conference after the meeting, Bank of Japan Governor Kazuo Ueda indicated that the rate could be raised flexibly in line with economic activity and commodity prices. It marked a notable shift from the previously cautious approach that allowed ample time to implement a policy change.

At the press conference, Ueda said the bank plans to raise interest rates if economic activity and price expectations change in line with the bank’s forecasts or if the bank concludes that there is a risk that prices could rise more sharply than forecast in the future.

“There is a view that a gradual adjustment in interest rates will be beneficial overall,” Ueda said.

When the central bank decided to end its negative interest rate policy in March, it did so after closely monitoring the results of this year’s shunto spring wage negotiations and the large wage increases offered by big companies. Some market analysts see Wednesday’s decision to raise interest rates as another bold move. “This was a clear shift from the previously cautious approach,” said Ryutaro Kono of BNP Baribas Securities.

Ueda said he “did not pay special attention” to the fact that the highest policy rate in the past 20 years was 0.5%. Some market participants believe the central bank’s rate could eventually exceed 1.0%.

The bank’s quarterly forecast for economic activity and prices, published after the meeting, indicated that the annual increase in the consumer price index (including all items except fresh food), based on the median of policy council members’ forecasts, would likely be 2.1% for fiscal year 2025 and 1.9% for fiscal year 2026. These levels are close to the bank’s 2% inflation target, so the bank could continue to consider raising rates.

Few market participants initially expected the central bank to decide on a rate hike at Wednesday’s meeting. Even some bank officials were concerned that persistently rising prices were undermining consumer confidence and that a decision to raise rates would be premature. In fact, a survey of household income and expenditure conducted in May revealed that average monthly consumption expenditure per household of two or more people fell by 1.8% in real terms from the same month in 2023, when the impact of price fluctuations is excluded.

However, a series of comments from senior government and ruling party officials on the normalization of Japan’s monetary policy led to increasing speculation in markets that the central bank would raise interest rates.

On July 17, Digital Transformation Minister Taro Kono said in an interview with Bloomberg that the Bank of Japan should raise interest rates. Liberal Democratic Party Secretary-General Toshimitsu Motegi also spoke about normalizing financial policy. Both comments seemed to reflect the speakers’ awareness of public discontent over rising prices, but a senior Bank of Japan official offered a more cynical explanation.

“They were probably trying to improve their image ahead of the LDP presidential election in September,” the official said.

Still, market players saw these comments as ‘support’ for a rate hike.

At his press conference, Ueda declined to comment on the comments of senior government and ruling party officials. “I will not comment on those individual comments,” Ueda said. He added: “We will determine the bank’s policy appropriately, regardless of what political moves are made.”

Prime Minister Fumio Kishida welcomed the bank’s decision to raise interest rates. “While this will have an impact in terms of higher lending rates, it will also have the positive effect of raising the interest paid on people’s deposits and savings,” Kishida told reporters Wednesday night.