BOJ Official Hints at Rate Hike Due to Yen-Driven Inflation Impact‍

Summary

• Adachi emphasizes the importance for BOJ to assess both downside and upside economic risks.
• He suggests that BOJ would consider raising rates if trend inflation approaches 2%.
• Adachi anticipates a surge in consumer inflation from summer through autumn.
• He indicates that BOJ might expedite rate hikes in the event of continued substantial depreciation of the yen.
• BOJ plans to gradually decrease bond purchases to prevent disruptions in the market.

TOKYO/KUMAMOTO, Japan, May 29 (Reuters) - Seiji Adachi, a board member of the Bank of Japan, stated on Wednesday that the central bank might consider increasing interest rates in response to significant declines in the yen, which could lead to increased inflation or greater-than-anticipated changes in public expectations regarding future prices.

Adachi clarified that while minor fluctuations in currency values wouldn't prompt a change in policy, sustained and pronounced depreciations of the yen, especially if they significantly influence inflation expectations, could prompt the central bank to raise interest rates.

Additionally, he emphasized the importance for the Bank of Japan to consider not only the potential negative risks but also the positive risks concerning the economy and price levels when determining policy.

Adachi stated, "We must take care to avoid raising interest rates prematurely. However, if we overly focus on potential downsides, there's a risk of inflation accelerating unexpectedly, necessitating a significant tightening of monetary policy later."

He further mentioned, "As long as the underlying inflation trend moves toward 2%, it's crucial to gradually adjust the level of monetary support in response to economic, price, and financial developments." This suggests the possibility of a rate hike in the near future.

The statements underscore the increasing importance of a depreciating yen in determining when the Bank of Japan might enact its next interest rate increase, with speculation suggesting a possible move as early as July. Despite his remarks, the yen did not find support, weakening to its lowest level in four weeks against the dollar due to a rise in U.S. yields. The dollar reached an intraday peak of 157.41 yen before settling at 157.10 on Wednesday.

Adachi noted that consumer inflation is expected to pick up speed from summer through to autumn this year, driven by increasing import expenses and the likelihood of continued wage growth. He added, "Should the depreciation of the yen intensify or persist, consumer inflation could rebound earlier than anticipated. In such a scenario, if there's a heightened probability of inflation consistently surpassing the 2% threshold, we might need to advance the schedule for an interest rate hike."

Adachi mentioned during a news conference, after addressing business leaders in Kumamoto, southern Japan, that the BOJ plans to increase rates gradually in accordance with steady growth in underlying inflation. Despite the BOJ's decision in March to end eight years of negative rates, the yen has devalued by around 10% against the dollar this year. This devaluation is due to the significant difference in interest rates between the U.S. and Japan that the markets are currently focusing on. 

Policymakers are concerned about the impact of the weak yen on consumption due to higher import costs. Consequently, some market participants are speculating on the possibility of a rate hike in the near future to curb the yen's depreciation. In May, Japan's consumer confidence declined for the second consecutive month as households felt the pinch of increasing prices, as indicated by a survey from the Cabinet Office released on Wednesday. The government adjusted its evaluation of consumer sentiment downwards, stating that "improvements were stalling," in contrast to the previous month's assessment of ongoing improvements.

NO STEER IN RATE HIKE, TAPER TIMING

Anticipation of an imminent rate hike contributed to a rise in Japan's 10-year government bond yield to 1.07% on Wednesday, reaching levels not seen since December 2011. There are speculations among some traders that the BOJ might opt for a significant reduction in bond purchases next month, particularly after surprising the markets with an unexpected cut in bond buying on May 13.

Adachi mentioned that the BOJ plans to gradually decrease its bond buying in line with its decision in March to end the policy that had previously capped bond yields close to zero. However, he clarified that the reduction in bond buying on March 13 did not have any specific policy implications, and it is still too early to assess whether the recent upward trends in Japanese long-term yields will be sustained.

Adachi also expressed neutrality on the timing of any further reduction in bond purchases, emphasizing that the BOJ does not have a predefined plan or timeline for tapering. He assured that any reduction in bond purchases will be carried out in a phased manner to prevent market disruptions.

BOJ Governor Kazuo Ueda has indicated that the central bank aims to raise rates to levels that are considered neutral for the economy, provided that growth and inflation align with expectations. Moreover, the governor has highlighted that the BOJ intends to phase out the use of bond purchases as a monetary policy tool and eventually shrink the size of its extensive balance sheet.

Source: Reuters‍