Sliding Yen, Robust Economy Give BOJ More Grounds for Early Hike

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Sliding Yen, Robust Economy Give BOJ More Grounds for Early Hike.

foreign exchange :: 3hrs ago :: source - bloomberg

By Toru Fujioka

(Bloomberg) -- The Bank of Japan has an increasingly strong case to consider an early rate hike as business activity remains robust and the tumbling yen threatens to spur inflation above its price target.

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Until recently, economists generally saw the central bank hiking rates about every six months, which would put the next move in December. But now markets are pricing in a solid chance — over 60% — that another increase could come by October.

That could heighten tension between the bank and the government — as a key factor weighing on the currency is recent signaling from Prime Minister Sanae Takaichi indicating her preference for prolonged monetary easing. Speculation over the administration's resistance to hikes has helped push the yen to its weakest level against the dollar since 1986. With bets rising on Federal Reserve tightening, some traders have discussed the possibility of the currency weakening toward 200 per dollar.

Japan faces assorted cross-currents with its policy rate at a 31-year high and its currency near a 40-year low, but so far the economy has held up. The central bank's closely watched Tankan survey surprised markets Wednesday by showing business confidence improving in June to the highest in eight years, defying expectations that the conflict in the Middle East might weigh on sentiment. That helped alleviate one of the major concerns policymakers have cited before raising rates again.

"The chances of the next hike coming in October are rising," said Shinichiro Kobayashi, chief economist at Mitsubishi UFJ Research and Consulting. "The weaker yen is becoming another factor supporting an earlier move. The Tankan must have strengthened the BOJ's confidence in the economy's resilience."

The Tankan undermined a potential argument against rate hikes by showing that rate hikes to date haven't weighed on financing conditions. An index for financial positions among businesses improved for the first time in a year, while large firms reported that conditions for issuing commercial paper have improved.

That's consistent with comments Governor Kazuo Ueda made in early June, when he cited anecdotal evidence showing that labor shortages and the surge in material and other prices — not funding rates — were potential impediments to business investment. Indeed, a growing number of bankruptcies have been linked to the weak yen, which drives up import costs.

Against that backdrop, economists are increasingly highlighting the risk for a faster pace of rate hikes after the BOJ lifted its benchmark rate to the highest since 1995 last month.

Ahead of that meeting, 71% of economists surveyed by Bloomberg saw the central bank raising rates roughly once every six months. Hiroshi Shiraishi, senior economist at BNP Paribas SA, now sees October as his base case while acknowledging growing odds that the move could come as early as September. That would mark the shortest interval between rate increases under Ueda after five hikes so far.

"The risk is increasing that the BOJ will start to feel a greater sense of urgency about raising rates sooner than it otherwise would have," Shiraishi said, pointing to stronger demand-driven inflation and the prospect of additional Fed tightening. The gap between US and Japanese interest rates has historically weighed on the yen.

The Tankan also showed firms' longer-term inflation expectations rising to 2.6%, the highest on record going back to 2014. The BOJ has likewise estimated that inflation is running well above its 2% target once temporary factors including government subsidies are stripped out.

Yet politics continue to pull in the opposite direction.

Takaichi has consistently signaled her preference for accommodative monetary policy. Her two appointments to the BOJ board — Ayano Sato and Toichiro Asada — are both regarded as advocates of monetary easing. Asada cast the lone dissenting vote against last month's rate hike. After joining the board this week, Sato signaled her tilt toward easy policy.

The draft of the government's annual economic policy guidelines released in June reinforced that perception by stating that appropriate monetary policy is "very important" for achieving its goal of building a "strong economy." The wording added to the yen's decline by strengthening market perceptions that the BOJ may have to move cautiously on further normalization.

"It is becoming a vicious cycle," Kobayashi said, adding that the more markets believe the BOJ will delay rate hikes due to Takaichi's stance, the weaker the yen becomes. That pushes up inflationary pressure, increasing the likelihood that the BOJ eventually has to raise rates anyway, he said.

Deputy Governor Shinichi Uchida offered few clues about the timing of the next move at last month's press conference, repeatedly saying future decisions would depend on economic activity and inflation rather than a preset schedule.

The BOJ has already been forced to deviate from what many analysts once expected would be a steady normalization path after US tariffs, Takaichi's surprise rise to power and the conflict in the Middle East all complicated the policy outlook.

Another factor policymakers will need to watch is the government's expenditures. While temporary gasoline and utility subsidies have helped restrain headline inflation, Takaichi's pledge for responsible but aggressive fiscal spending could add to underlying price pressures over time.

"The government is expanding fiscal spending, which, in theory, puts upward pressure on prices eventually," former BOJ Executive Director Kenzo Yamamoto said. "The economy is now in a situation where the BOJ needs to raise rates sooner in order to contain those inflationary pressures."