The Bank of Japan (BOJ) is preparing for an era of consistent interest rate increases as it claims victory over long-standing deflation, according to sources and analysts. This shift marks a significant policy review that acknowledges major changes in consumer behavior.
This review signals a departure from former governor Haruhiko Kuroda’s aggressive monetary stimulus policies, moving towards a more conventional approach targeting short-term interest rates. Despite the BOJ’s statement that the review, led by governor Kazuo Ueda, won’t directly influence future monetary policy, it indicates a shift in the central bank’s perspective on inflation.
“The BOJ is leveraging the idea of Japan’s evolving social norms to support its projection that inflation will sustainably reach 2% in the coming years, a prerequisite for rate hikes,” said Nobuyasu Atago, a former BOJ official and current chief economist at Rakuten Securities Economic Research Institute.
Two sources familiar with the BOJ’s thinking suggest the review will help the central bank argue that Japan’s economy can handle a gradual increase in near-zero interest rates. “The key message is that Japan’s deflationary norm has changed,” one source said. “It’s essentially saying that Japan is ready for higher rates.”
Under Kuroda’s 2013 “bazooka” stimulus, the BOJ aimed to combat deflation with massive money printing to achieve a 2% inflation target within two years. However, this goal was ultimately reached due to external factors such as pandemic-induced supply constraints and the war in Ukraine, which increased import costs and sustained inflation above 2% for over two years.
Now, the BOJ is pointing to shifts in household and corporate behavior as evidence that this time is different in Japan’s battle with deflation. Deputy governor Shinichi Uchida noted that Japan is on the verge of overcoming a “deflationary norm,” where households and firms believe prices and wages will remain stagnant. Uchida described recent labor market changes as structural and irreversible.
Indeed, public perceptions are changing. Japanese consumers, like Aki Kuramoto, a 55-year-old office worker with two children, are preparing for a period of rising prices. “I think inflation will last for a while, and product prices will rise further,” she said while shopping in Tokyo.
Uchida’s views on inflationary perceptions reflect the review’s emphasis on structural changes in the economy. After decades of flat or negative growth, core inflation has exceeded the BOJ’s 2% target for over two years, reaching 2.6% in June. Companies, facing a severe labor shortage due to an aging population, have implemented the largest wage hikes in three decades, making it easier to raise prices.
However, the review also highlights the negative side-effects of past stimulus measures. Over 25 years, prolonged low rates have sharply reduced financial institutions’ profitability.
The BOJ’s review won’t change its 2% inflation target or its policy framework but underscores its intention to adjust short-term rates to levels that neither cool nor stimulate growth, estimated by analysts to be between 0.5% and 1.5%.
While the full review outcomes will be published later this year, early findings indicate progress towards achieving a cycle where higher prices lead to higher wages, essential for rate hikes. A survey of 2,509 companies released in May revealed that many view an economy with rising prices and wages more favorably than one with stagnation.
For some, like Junya Oyama, a 56-year-old electronics manufacturer employee, wage hikes haven’t kept pace with price increases, but inflation remains manageable. “Young people might find it difficult to cope with rising prices, but higher prices are not giving me much trouble and are within the acceptable range,” he said.
