BOJ May Revert to Fuzzy Communication after Fed-Style Clarity on Rates

Reuters

10:18 JST, January 27, 2025

TOKYO (Reuters) – The Bank of Japan, after clearly signaling last week’s interest rate hike, may return to its accustomed fuzzy guidance about central bank policy to maintain flexibility when it eventually begins to consider how much tightening is enough.

The BOJ fumbled its communication in December, surprising investors when it left rates steady, but then telegraphed Friday’s increase so unambiguously that markets had 90% priced it in and took the move in stride.

That shift to clearer guidance, an approach the U.S. Federal Reserve used in August to signal a policy shift, may prove temporary. Japanese policymakers fear being led by the markets and are unsure how far the BOJ can raise rates without cooling growth, say analysts and people familiar with the central bank’s thinking.

Policymakers are wary of feeling they must give clear signals before each meeting, given an uncertain economic outlook, and they lack conviction about the Goldilocks “neutral” interest rate that neither chills nor overheats the economy.

After the BOJ caught markets off guard with December’s decision, Governor Kazuo Ueda flagged uncertainty over U.S. economic policy ahead of Donald Trump’s return as president as a key reason it had refrained from raising rates.

Considered dovish, Ueda’s comments pushed down market pricing of January action to 46% from 70%.

Keen to avoid startling markets again, the BOJ then laid the groundwork for the January hike, taking a page from Fed Chair Jerome Powell, who had explicitly signaled an imminent shift by pronouncing that “the time has come for policy to adjust.”

COSTS OF CLARITY

Ueda and his deputy Ryozo Himino each said during the week before Friday’s hike that the BOJ board would “debate whether to raise rates” – effectively pre-announcing its decision to double short-term rates to 0.5%.

“Without those comments, a January hike would have been a huge surprise,” said Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities. “The BOJ probably had no other choice.”

Asked about the advance warnings, Ueda said after Friday’s decision they were simply a “reminder” that the board would discuss the feasibility of changing policy at every rate review.

But while the strategy let the BOJ smoothly raise its policy rate to the highest in 17 years, it is not without cost.

Markets may focus too much on BOJ commentary, rather than scrutinizing economic and price data, to gauge the bank’s next rate hike, analysts say.

Giving explicit advance signals, in addition to making the BOJ feel boxed in, could breach Japanese law stipulating the nine-member board must debate and sign off on rate decisions at each policy meeting.

“It raises some alarm bells,” a former policymaker said of the BOJ’s communication about Friday’s rate hike. “The market ought to be a guide for central banks on how the economy is doing. But if this practice continues, the BOJ will only see in the market a reflection of itself.”

‘GREATER VARIABILITY’

Another reason to revert to ambiguity is uncertainty over the end point for tightening.

BOJ staff estimates Japan’s nominal neutral rate between 1% and 2.5%. While that has not been a factor so far with the policy rate so low, two more hikes would bring it to the bottom of that range – a level many analysts consider the neutral rate.

Indeed, while signaling the bank’s resolve to keep raising interest rates, Ueda gave few clues on Friday of the pace or timing of further hikes and said it was hard to pin down Japan’s neutral rate in real time.

“Because the BOJ doesn’t know where exactly the neutral rate is, it would have to wait about six months after each hike to check the health of the economy,” said Izuru Kato, chief economist at Totan Research. “Only after judging that the neutral rate is still distant would it raise rates again.”

Other complications loom as the BOJ eyes further rate hikes, which could heighten challenges in trying to convince the public of the need to keep pushing up borrowing costs.

The bank justified Friday’s increase by citing prospects of sustained wage gains, but it is uncertain whether consumption can weather rising living costs.

Trump’s threats of higher tariffs could weigh on Japan’s export-reliant economy and business sentiment.

“The BOJ’s hands are looking increasingly tied with the complex task of managing price pressures, reflation efforts and market expectations all together,” said Frederic Neumann, chief Asia economist at HSBC Bank, adding that risks surrounding Trump’s policy cannot be dismissed.

“These all translate to greater variability as to the policy rate path going forward.”