A look upon Japan’s monetary policy

Japan has kept interest rates low for a long time to combat deflation, boost economic growth, and address challenges like its aging population and low inflation. The Bank of Japan (BOJ) has used strategies such as keeping rates low and unconventional methods like quantitative easing to encourage spending, investment, and inflation, while also managing high public debt. While results have been mixed, these efforts have helped stabilize the economy, support exports, and foster recovery during a long period of slow growth. The key question now is: what actions has the BOJ taken recently?

In March, the BOJ ended its negative interest rate policy and raised its short-term policy rate to 0.25% in July. A signal that another rate hike might be coming came on December 19, when BOJ Governor Kazuo Ueda said the economy is moving toward sustained wage-driven inflation. He also stressed that raising rates gradually from very low levels will support long-term growth.

This approach is similar to the BOJ’s 2007 rate hike cycle, when Governor Toshihiko Fukui argued that reducing stimulus early would help avoid bubbles and ensure stable growth. Back then, the BOJ raised rates twice, from zero to 0.5%, but had to reverse course in 2008 due to the global financial crisis, keeping rates near zero for the next 16 years.

The big question now is when the BOJ will raise rates again. Governor Ueda is confident that rising wages will boost consumption and help companies keep raising prices, setting the stage for further rate hikes. While he acknowledges risks from U.S. economic uncertainty and market volatility, Ueda has suggested that the BOJ might act even before all these risks are resolved, with a possible rate hike at the meeting on December 19. Although BOJ policymakers haven’t set a specific timeline, they seem to expect a rate increase to 0.5% by the end of March.

The BOJ’s outlook on the neutral rate—where monetary policy is neither too tight nor too loose—indicates it will continue raising short-term rates as the economy recovers. Currently, the short-term rate is 0.25%, despite inflation staying around 2% for over two years, keeping borrowing costs low. The BOJ aims to reduce what it sees as excessive monetary stimulus by bringing rates to a more neutral level.

However, estimating the neutral rate is difficult because it’s not directly observable and varies depending on the model used. The BOJ’s estimates suggest Japan’s real neutral rate is between -1% and +0.5%. If inflation hits the BOJ’s 2% target, it could raise rates to about 1% without hurting growth.

The BOJ’s forecast from October suggests short-term rates may reach the neutral rate by the second half of its three-year projection period, likely after October 2025. While board member Naoki Tamura suggested the BOJ might need to raise rates to 1% by late next year, other members have not commented on the neutral rate. Governor Ueda has said it’s hard to make credible estimates due to the long period of zero rates in Japan.

Stay informed about global markets through our previous analyses. and Now, you can also benefit from LDN company services via the LDN Global Markets trading platform.