Once seen as a cautious policy dove, Bank of Japan Governor Kazuo Ueda is now presenting himself as a determined hawk who's not afraid to lift interest rates a few more times, even in the face of a weakening economy.
A change in Ueda's commentary comes as the central bank grows more confident that steady wage gains will revive consumption, and reflects concerns that leaving rates low for too long could keep the yen weak and lead to a painful, unpopular inflation overshoot.
Ueda's latest hawkish hints and Japan's still-low real interest rates mean the BOJ has its eyes set on hiking rates at least to around 0.75%, notwithstanding economic shocks, sources and analysts say.
"Ueda's remarks suggest that even if the economy's momentum is somewhat weak, the BOJ will raise rates further unless its projection of an economic expansion is derailed," said Yoshimasa Maruyama, chief market economist at SMBC Nikko Securities.
In a press conference explaining the BOJ's decision to raise short-term rates to 0.25% on Wednesday, Ueda said there was "still quite some distance" before its policy rate reaches a neutral level that neither cools nor overheats the economy.
Ueda also said 0.5%, a level Japan has not seen since 2008, posed no barrier to rates going even higher.
While he declined to specify Japan's neutral rate level, three sources familiar with the BOJ's thinking said the dominant view within the central bank is for it to be around 1-1.5%.
That suggests the BOJ is pencilling in at least two more 25 basis point hikes to 0.75%.
Hikes that big would help remove excessive monetary support but wouldn't create restrictive monetary conditions, and would only need inflation data to move roughly in line with BOJ forecasts.
Only when short-term rates approach levels deemed neutral would the BOJ's policy decision become sensitive to more subtle signs of weakness in the economy, the sources said.
"The March policy change was an extraordinary move. After that, it's business as usual," one of the sources said on how rates can follow a steady trajectory without much advance hints from the central bank on the specific timing of a change.
MORE TO COME
When the BOJ ended negative interest rates and other remnants of its massive stimulus in March, the focus of its communication was to avoid jolting markets with too-hawkish signs on the policy outlook.
With markets having digested the impact of the March move, the BOJ is now shifting towards sending clearer signals on the prospect of a full-fledged rate hike cycle, the sources said.
Underscoring the BOJ's hawkish bent, the BOJ said in a quarterly outlook report on Wednesday that it will "continue to raise its policy rate" as long as the economy and inflation move in line with its forecast.
That compared with the previous report's language pledging to "keep financial conditions loose," even if the BOJ were to fine-tune the degree of monetary support.
The BOJ's decision to hike rates on Wednesday also came despite recent weak signs in consumption, which led many economists to bet it will stand pat to gauge more data. Two dovish members of the board dissented to the rate decision.
Ueda escalated his warning on the demerits of the weak yen, saying there was "quite a significant risk" the boost it gives to import costs may push up inflation more than expected.
His remarks on Wednesday more explicitly linked the inflationary threat to the yen's declines than his previous comments on the currency's impact have.
The BOJ's hawkish determination is finally getting across to markets. JPMorgan now expects the BOJ to hike rates to 0.5% in December, followed by two more hikes to 1% by end of 2025.
Former BOJ board member Takahide Kiuchi, who is currently an economist at Nomura Research Institute, thinks the BOJ will aim to push up rates near 1% including through two hikes by early next year.
"Ueda hiked rates this month on the view that inflation was on track to meeting the BOJ's projections," said former BOJ official Nobuyasu Atago, currently chief economist at Rakuten Securities Economic Research Institute.
"Judging from the statement's language, one might need to guard against the possibility of another rate hike when the BOJ issues its next outlook report in October," he said.
