Sources familiar with the matter have disclosed that the government under Prime Minister Takaichi Sanae is backing the Bank of Japan (BOJ) in raising interest rates in the near future, with the next move likely occurring in September or October. These sources added that the central bank's concerns over a weaker yen driving up prices align with the government's desire to bolster the effectiveness of recent U.S.-Japan currency intervention efforts, leading to a consensus on the need for an imminent rate increase.
Although the BOJ holds statutory independence in monetary policy, it is required to maintain close communication with the government on economic policy objectives. The Takaichi Sanae cabinet cannot compel the BOJ to set specific interest rates, but it can send signals that may influence its decision-making. In an emailed statement, the Prime Minister's Office said, "We believe that specific monetary policy measures, including rate hikes, should be decided by the Bank of Japan." The statement further noted that the central bank should work closely with the government to achieve the 2% inflation target in a "stable" manner. The BOJ declined to comment.
Following the announcement, the yen strengthened against the U.S. dollar from around 159.46 to 159.18, while the benchmark 10-year government bond yield edged slightly higher. Investors remain cautious, as the impact of the first joint U.S.-Japan yen-buying intervention since 1998 appears to be fading. There is growing anticipation in the market that the BOJ will join efforts to support the yen, with U.S. Treasury Secretary Scott Bessent signaling that such a move is necessary.
During a press conference after the BOJ's decision to hold rates steady on July 31, Governor Kazuo Ueda raised the possibility of accelerating the pace of rate hikes, citing concerns over risks of rising price pressures. Later that day, the U.S. and Japan jointly intervened in the foreign exchange market to support the yen. According to one of the sources, the government had expressed support to the BOJ before the July meeting for Governor Ueda to adopt a hawkish stance in his press conference. The source added that BOJ officials still want to assess economic and price developments before making a final decision on the timing of the next rate hike, but they have not ruled out acting in September.
As of noon Thursday in Tokyo, traders were pricing in a 74% probability of a rate hike at the BOJ's next policy decision on September 18. Takaichi Sanae has long been viewed as cautious about rates rising too high or too quickly, fearing it could stifle the economic recovery that has excited global investors. Although the BOJ has raised rates twice since she took office in October last year, the benchmark rate remains at a low 1%. A third rate hike would mark the fastest pace of tightening in 12 months since 1989, during the peak of Japan's economic asset bubble.
The significant interest rate differential between the U.S. and Japan is one factor driving the yen's weakness. The yen's depreciation has exacerbated inflationary pressures, intensifying the cost-of-living crisis that voters want Takaichi Sanae to address. In recent weeks, government officials have expressed support for the BOJ's independence, which may signal their openness to further tightening. On Monday, Minister of State for Economic and Fiscal Policy Minoru Kiuchi said in an interview, "We respect the bank's independence."
The government and the BOJ signed a joint agreement in 2013, committing to work together to promote economic growth. That agreement established the BOJ's 2% inflation target. In the summary of opinions from the BOJ's July meeting, one board member stated that greater flexibility in monetary policy is necessary. Another policy board member noted that, given the core CPI inflation rate is close to 2%, "it is possible to think that the pace of policy rate hikes will be faster than the market expects."
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