The Bank of Japan (BOJ) is expected to maintain its commitment to further interest rate hikes at next week's policy meeting while signaling to markets that future moves will strictly depend on economic responses to each adjustment, rather than a predetermined endpoint.
According to sources cited by Reuters on the 12th, the BOJ may uphold its rate hike pledge next week, with the pace of increases contingent on how the economy reacts to each move. A recent survey shows that 90% of economists predict the BOJ will raise rates by 25 basis points at its December 18-19 meeting, with market pricing indicating a roughly 90% probability of a hike to 0.75%.
However, sources noted that the BOJ will avoid using its "neutral rate" estimate as the primary communication tool for guiding future rate hikes. Instead, the central bank will emphasize that upcoming decisions will be based on observing how past rate increases affect bank lending, corporate financing conditions, and broader economic activity to determine the timing of the next move.
This communication strategy aims to dispel market expectations of a linear path where the BOJ mechanically stops hiking as rates near the lower bound of the neutral range. By downplaying specific neutral rate levels, the BOJ seeks to retain policy flexibility amid complex economic conditions, ensuring monetary adjustments align with the real economy's capacity.
Despite Japan's inflation exceeding the 2% target for over three years, inflation-adjusted real borrowing costs remain deeply negative. Sources say this will be a key argument for the BOJ to justify further tightening next week.
One source stated that Japan's extremely low real interest rates allow the BOJ to continue gradual hikes. Even if the policy rate rises to 0.75%—a level unseen in three decades—it would still remain relatively accommodative.
Market participants had closely watched how far the BOJ might raise rates before reaching the "neutral level" that neither stimulates nor restrains growth. The BOJ currently estimates neutral rates between 1.0% and 2.5%. A hike to 0.75% would bring rates near the bottom of this range, leading some to speculate the BOJ may pause significant further hikes to avoid economic harm.
Sources revealed the BOJ will clarify that while neutral rates are an important reference for policy, they won't be the decisive factor in timing future hikes. Given the difficulty of precise estimation, the central bank won't use neutral rate projections as a primary communication tool. Internal updates to these estimates are unlikely to be published before next year, as officials view neutral rates as unobservable and variable over time.
The BOJ wants markets to understand its decision-making hinges on dynamically assessing the distance to neutral by examining each hike's economic impact.
This step-by-step approach has support from both BOJ insiders and external experts. BOJ board member Asahi Noguchi warned last month that over-reliance on neutral rate estimates is risky since measuring exact levels is "virtually impossible." He advocated setting a benchmark range and gradually raising rates while monitoring economic effects.
Former top BOJ economist Seisaku Kameda noted the central bank may grow more cautious as rates approach neutral territory. While the BOJ could update its neutral rate estimates, Kameda stressed the key message after a 0.75% hike should be that monetary conditions remain accommodative.
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