Inflation Impacts Lead to Interest Rate Hikes

The weakening yen may be pushing the Bank of Japan to raise interest rates sooner than expected, so be alert for a surprise move!

Bank of Japan policy board member Seiji Adachi stated on Wednesday that if the yen's significant depreciation raises inflation or if public expectations for future price trends exceed forecasts, the Bank of Japan may consider raising interest rates.

Adachi said in a speech that while short-term exchange rate movements by themselves would not trigger a policy shift, if the yen continues to fall excessively and significantly impacts inflation expectations, the central bank may raise interest rates.

He also indicated that when guiding policy, the Bank of Japan must consider not only the downside risks to the economy and prices but also the upside risks. "We must do everything we can to avoid raising interest rates too early. However, if we focus too much on the downside risks, we might see inflation accelerate, forcing us to subsequently tighten monetary policy significantly."

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He said, "As long as core inflation continues to head towards the 2% target, it is necessary to gradually adjust monetary policy to reflect developments in the economy, prices, and finance." He hinted at the possibility of a rate hike in the near future.

Adachi's remarks highlight the increasing influence of the yen's depreciation on the timing of the Bank of Japan's next interest rate hike. Some analysts believe that the earliest the Bank of Japan could raise rates might be in July.

Adachi stated that although the Japanese economy may not currently be robust, consumption, exports, and capital spending may recover as households begin to benefit from rising wages and overseas economies show signs of recovery.

He also said that Japanese consumer inflation will accelerate again around this summer to autumn due to rising import costs and the prospect of continued wage increases. "If the yen depreciates more rapidly or continues to fall, consumer inflation may rebound faster than expected. If this happens at a time when the likelihood of inflation remaining steadily above 2% is higher, we may need to raise interest rates earlier."

Adachi said that the Bank of Japan will also reduce the scale of bond purchases at some point in the future, adding that any action to reduce bond purchases will be carried out in several stages to avoid disrupting market stability.

Despite the Bank of Japan's decision in March to end eight years of negative interest rates, the yen has depreciated by about 10% against the US dollar this year. The yen has depreciated by 1.5% against the euro this month, approaching the historical low of 171.56 set on April 29, and has fallen to its lowest level against the British pound in nearly 16 years at 200.63.The weak yen has become a headache for Japanese central bank policymakers, who are concerned that rising import costs will hit consumption and lead some market participants to bet on the possibility of interest rate hikes in the near future to slow the yen's depreciation.

Although the Bank of Japan has ruled out the possibility of using monetary policy to influence exchange rate trends, some government and corporate executives have been calling on the central bank to continue raising interest rates that are close to zero due to growing concerns about the yen. Bank of Japan Governor Haruhiko Kuroda has said that as long as economic growth and inflation are in line with the central bank's expectations, the central bank intends to raise interest rates to a level considered neutral for the economy.

Monex foreign exchange dealer Helen Given said, "Even if the Bank of Japan raises interest rates again, it cannot stop traders from selling yen. Unless other G10 central banks unexpectedly introduce policy easing measures that far exceed current market expectations, the yen has almost nothing to rely on."

Mitsubishi UFJ Bank foreign exchange trading department head Go Ohara said, "The euro and pound against the yen may still have room to rise. Although some investors have liquidated accumulated long dollar positions, they have all bought European currencies such as the euro and pound, providing additional support for these two currency pairs."