Bank of Japan Governor Kazuo Ueda stated that the current core inflation level is "already quite close" to the central bank's 2% inflation target. Strong global demand for artificial intelligence (AI), combined with inflationary pressures from a tight labor market, has left room for further rate increases.
These remarks come as the Bank of Japan prepares to hold a key policy meeting later this month, at which it will release its latest quarterly growth and inflation forecasts. Markets will scrutinize these projections closely for clues on the timing of the next rate hike.
"It is becoming increasingly important to anchor core inflation near the 2% target," Ueda said Monday in parliament.
Ueda noted that while Middle East conflicts are pushing up raw material costs and thereby fueling inflation, a tight labor market and a moderate economic recovery are also generating demand-side price pressures.
"Global AI demand is very strong, which is boosting capital expenditure and export growth, and in turn driving up prices for a variety of goods," he pointed out.
Ueda also said that raising interest rates at an appropriate pace would help prevent bond yields from surging.
"With core inflation approaching 2% and the current financial environment still accommodative, if we fail to adjust the policy rate appropriately, markets may worry about inflation overshooting, which would push up long-term interest rates," he said.
The Bank of Japan will conclude its two-day policy meeting on October 30. Sources said the central bank had just raised rates in September, and many board members are cautious about another hike this month, preferring to observe more data to assess the impact of the previous increase on financial conditions.
Many market participants expect the Bank of Japan to keep rates unchanged at 1.25%, but it may signal that it is keeping the door open for a rate hike to 1.5% as early as December.
Managing Debt Issuance
Japanese government bond yields have risen amid market expectations of further rate hikes by the Bank of Japan, combined with concerns that Prime Minister Sanae Takaichi's large-scale spending plans could worsen the country's already strained fiscal position.
When asked in parliament by an opposition lawmaker about the impact of fiscal spending on inflation, Ueda responded that expanding fiscal expenditure would stimulate the economy and drive up prices and wages. However, he added that if increased fiscal spending enhances Japan's supply capacity, it could conversely help moderate inflation over the longer term.
Ueda reiterated that emergency bond purchases would be reserved for situations involving sharp yield spikes or severe market dysfunction.
At the same parliamentary session, Takaichi dismissed claims by some analysts that her government's policies had triggered a sell-off in the yen and Japanese government bonds.
"We will carefully examine the scale of fiscal spending and appropriately manage the size of debt issuance," Takaichi said. "By building a strong economy, Japan can enhance market confidence in the yen."
The Japanese government bond market has stabilized after the government sought to ease concerns that it is pursuing inflation-stimulating policies. However, analysts expect renewed turbulence if the government fails to clearly explain how it will fund tax cuts and large-scale spending programs.
The International Monetary Fund (IMF) last week urged the Bank of Japan to continue raising interest rates and called on the government to establish a medium-term fiscal framework to ease market unease.
"Markets are concerned about fiscal risk because there is uncertainty over how Japan will pay for new spending and tax cut plans," said Krishna Srinivasan, director of the IMF's Asia and Pacific Department.
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