24 January 2025

Research

Japan: The Bank of Japan Between Confidence and Caution 

Van
Thuy Van Pham, Economist

The Bank of Japan (BoJ) raised its key interest rate by 25 basis points to 0.5% following its meeting on January 23-24, 2025. This marks the third hike after those implemented in March and July 2024.

Beyond the announcement, several key points stood out from the official statement and the press conference held by Governor Kazuo Ueda:

1/ The BoJ justified its decision based on financial market stability, the resilience of the U.S. economy, and the limited impact of President Trump’s trade policy on Japan’s economy so far. More importantly, the institution expressed greater optimism regarding economic activity and price developments, stating that these are "in line" with the projections presented in the October 2024 quarterly report. Now, "the likelihood of meeting these projections has increased." In particular:

  • • Wage prospects are more favorable (see Chart 1). Many companies have expressed their intention to continue increasing wages steadily during this year’s annual spring negotiations, supported by improving profits and labor shortages.
  • • Inflation remains above the 2% target (see Chart 2). With rising wages and higher production costs—partly due to the weak yen—inflation projections have been revised upward. Core inflation (excluding fresh food) is expected to reach 2.4% in fiscal year 2025 (compared to the 1.9% projected in October 2024). It is expected to remain around the 2% target in 2026 (compared to 1.9%).

• Lastly, economic activity has recovered moderately, and the persistence of negative real interest rates should continue to provide significant support for growth.

Japon salaires
Japon prix consommation

 

2/ However, the BoJ is in no hurry to tighten its monetary policy further. It has "no predetermined idea" about the timing of the next rate hike and will make decisions "meeting by meeting," based on data and whether its economic forecasts materialize. What is certain is that the BoJ is still far from the neutral rate. On this point, Mr. Ueda has not changed his stance: the neutral rate remains within a broad range of 1% to 2.5%, meaning that current monetary policy is still far from the "neutral zone."

That said, the central bank is not "behind the curve," as core inflation remains moderate. Moreover, it is most appropriate to maintain a gradual, step-by-step approach because:

  • 1/ The risk of Japan slipping back into long-term deflation is not zero (although this probability seems quite low); and
  • 2/ The BoJ must "also observe how rate hikes affect the economy."

While the decision to raise the short-term rate was widely expected by markets, the BoJ’s stance and communication continue to surprise us. Since November 2024, the central bank has developed a habit of not adhering to its "forward guidance" issued at the end of its meetings and instead signaling its decisions one week before the next meeting.

Substantively, the BoJ has been rather contradictory—showing increased confidence in economic and price prospects (as reflected in upward inflation revisions) while maintaining persistent caution regarding the "timing" and extent of further monetary normalization.

We continue to believe that the trajectory of wages and its impact on prices will remain the key determinant of the BoJ’s next move. The spring wage negotiations, with initial results expected from March, will therefore be crucial.

Regardless of the "timing," our monetary policy outlook remains unchanged: normalization will continue but cautiously, with two additional hikes expected and a terminal rate of 1% by the end of 2025. The recent resurgence of inflation and depreciation pressures on the yen could push authorities to act before summer. However, the arrival of new voting members on the Committee starting in April and the key elections scheduled for July 20 could shift the outlook.

 

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