Sources familiar with the matter have disclosed that the government led by Prime Minister Sanae Highashi is backing the Bank of Japan (BOJ) to raise interest rates in the near term, with the next move likely to occur in either September or October.
The central bank's concerns over a weaker yen fueling price increases align with the government's desire to strengthen the impact of recent joint US-Japan currency intervention, according to the sources, who added that both sides have reached a consensus on the necessity of a near-term rate hike. While the BOJ holds statutory independence in monetary policy, it is also required to maintain close communication with the government on economic policy objectives. The Highashi cabinet cannot force the central bank to set a specific interest rate, but it can signal views that may influence its decisions.
The Prime Minister's Office stated in an emailed release: "We believe that specific monetary policy measures, including interest rate hikes, should be determined by the Bank of Japan." The statement added that the central bank should collaborate closely with the government to achieve the 2% inflation target in a "stable" manner. The BOJ declined to comment.
Following the news, the yen strengthened against the US dollar to around 159.18 from 159.46, while the benchmark 10-year government bond yield edged higher. Investors remain cautious as the effects of the first joint US-Japan yen-buying intervention since 1998 appear to be fading. Market expectations are growing that the BOJ will step in to support the yen, especially after US Treasury Secretary Scott Bessent signaled that such a move is necessary.
During a press conference after the central bank held rates steady on July 31, BOJ Governor Kazuo Ueda mentioned the possibility of accelerating the pace of rate hikes, citing concerns over the risk of rising price pressures. Later that day, the US and Japan jointly intervened in the currency market to support the yen. According to one of the sources, the government had already expressed support to the BOJ before the July meeting for Ueda to deliver hawkish remarks at the press conference.
The sources added that central bank officials still want to assess economic and price developments before making a final decision on the timing of the next rate hike, but have not ruled out acting in September. As of noon Tokyo time on Thursday, traders were pricing in a 74% probability that the BOJ will raise rates at its next decision on September 18.
Highashi has long been viewed as cautious about interest rates rising too high or too fast, fearing it could stifle the economic recovery that has excited global investors. Although the BOJ has already acted 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, when Japan's asset bubble was at its peak.
The wide interest rate differential between the US and Japan is one of the factors driving the yen's weakness. The yen's depreciation has exacerbated inflationary pressures, worsening the cost-of-living crisis that voters want Highashi to address. In recent weeks, government officials have indicated they support the BOJ's independence, which may be a sign they are open to further tightening. Last Monday, Minister of State for Economic Revitalization Minoru Kiuchi said in an interview: "We respect the central bank's independence."
A joint agreement between the government and the BOJ, signed in 2013, commits both parties to working together to promote economic growth. That agreement established the central bank's 2% inflation target. In the summary of opinions from the BOJ's July meeting, one board member said it was more necessary to maintain flexibility in monetary policy. Another policy board member noted that, given the underlying CPI inflation rate is close to 2%, "it can be considered that the pace of policy rate hikes will be faster than market expectations."
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