Weakening yen complicates BOJ’s rate hike decisions; Rising commodity prices could impact the ‘Virtuous Cycle’ efforts

A weaker yen – which will cause prices to rise again due to rising commodity prices – will make it more difficult for the central bank to decide on additional interest rate hikes.

The Bank of Japan is committed to the virtuous cycle of rising wages and prices, an important factor in their decision to raise interest rates. The depreciation of the yen may make it more difficult to determine the extent to which a positive cycle has been achieved.

The yen weakened against the dollar on currency markets after the BOJ decided to leave its key interest rate unchanged at its Monetary Policy Meeting on Friday.

At a press conference at BOJ headquarters, Governor Kazuo Ueda was asked many questions about the impact of the weak yen and the strong dollar, such as: “How do you think the weak yen affects prices?”

In response, Ueda said that the current level of yen depreciation has not affected underlying inflation so far, except for temporary factors.

Ueda said the chances of achieving the target of a stable price increase of 2% are increasing. If prices rise in line with expectations, the bank plans to adjust the level of monetary easing, he said. Then the BOJ will probably consider raising rates further.

However, a weaker yen will drive up inflation by raising the prices of imported goods. Ueda stated that there is a non-zero risk that exchange rate fluctuations will affect the pace of price increases in the future.

Many believe the yen will continue to weaken against the dollar for the foreseeable future as speculation grows that the Federal Reserve will not cut interest rates.

Given calls from the business community and others to address the weakening yen, the BOJ could be forced to take action before it can see the virtuous cycle being achieved.

A further increase in interest rates would have a significant impact on people’s lives as it would lead to an increase in interest charges on variable rate home loans and an increase in interest rates for businesses.

“[An additional interest rate hike] would affect a large number of economic entities. We will proceed with caution and take into account the possible divergent consequences,” Ueda said.

“The BOJ needs to explain more thoroughly to the public why it is targeting 2% inflation while high prices are becoming a burden on people’s lives,” said Izuru Kato, a BOJ watcher at Totan Research Co.