TOKYO (Kyodo) -- The Bank of Japan went ahead with its second interest rate hike this year, defying the dominant market view that the shaky state of the Japanese economy would deter the dovish central bank from taking such a risk.
Combined with a reduction in government bond purchases that would herald a new era of quantitative tightening for the BOJ, the rate increase decision raises the question of whether the Japanese central bank's perceived hawkish tilt is real.
The yen got an immediate boost from the policy change decision but its persistent weakness, blamed on the BOJ's aggressive monetary easing, is increasingly haunting policymakers.
"The BOJ had to sound hawkish, or the yen would've fallen," said Mari Iwash*ta, chief market economist at Daiwa Securities Co.
"That being the case, it is still part of the BOJ's ongoing move to shift from its too-dovish tone (that weakened the yen). They had to act this time to live up to expectations after calls by Liberal Democratic Party lawmakers and Japan's market interventions," she said.
In a rare move leading to the BOJ's policy review, Digital Minister Taro Kono said higher interest rates would strengthen the yen in an interview with Bloomberg. Toshimitsu Motegi, the LDP's secretary general, followed suit, urging the central bank to consider raising interest rates.
Governor Kazuo Ueda acknowledged that the decision to increase the rate was preemptive, taking into account upside risks to inflation caused by the yen's weakening, which boosts import costs and deals a blow to the resource-scarce nation.
The BOJ chief downplayed the potential negative impacts of the rate increase to around 0.25 percent from the previous zero-to-0.1 percent range, and left the door open for another hike this year, depending on incoming data.
"Things will become easier if we adjust rates now, only a little," Ueda told a post-meeting press conference when asked if it was a hasty move.
BOJ policymakers had been encouraged by robust wage growth, the long-missing link in their efforts to achieve sustainable inflation driven by domestic demand rather than temporary factors like the yen's effect on import costs.
"It will depend on what incoming data shows, but if they come in line with or even overshoot our forecasts, we will make an additional adjustment to short-term interest rates," he said.
The tone marked a change after Ueda, who took the helm in 2023, used to warn of tightening policy prematurely and hurting the prospect of achieving its 2 percent inflation target.
Yuichi Kodama, chief economist at the Meiji Yasuda Research Institute, thinks the policy rate could reach 1.0 percent after another hike this year, followed by two increases in 2025.
"Governor Ueda is known to be more cautious and dovish among the board members," he said. "If the BOJ waits longer, it will end up gathering more attention, so it was perfect timing before a rate cut in the United States and (ruling party) elections in Japan," he said.
Still, economists are cautious about the economic outlook after a sharp contraction in the January-March period, underscoring weakness in consumption amid the rising cost of living. The highest pay hike in three decades offered by Japanese firms during this year's annual wage talks has yet to be felt by many consumers.
The rate hike decision came as Japan is at a critical juncture to realize a positive cycle of pay and price hikes, seizing what Prime Minister Fumio Kishida describes as the "golden opportunity" to shift to a new stage after years of deflation.
Under Ueda, the BOJ is steadily moving away from the unorthodox monetary easing measures that were a hallmark of his predecessor's tenure.
With the negative interest rate and yield curve control scrapped, the BOJ will reduce its buying of Japanese government bonds, halving it by March 2026 from the current 6 trillion yen ($40 billion) a month. This move would trim the central bank's balance sheet, which is larger than the roughly 600 trillion yen Japanese economy.
The BOJ owns more than half of the outstanding state debt and is criticized for its huge presence in the bond market. After the taper plan, the focus shifts to how much commercial banks and other financial institutions are willing to buy, with some market estimates putting the amount at around 100 to 200 trillion yen.
The reduction in bond-buying will not mean Japan's long-term bond yields will rise sharply and immediately lead to higher debt-servicing costs for the government.
For many Japanese long accustomed to ultralow rates, uncertainty remains over whether the envisaged shift to higher interest rates will be smooth and if the economy can remain on a recovery path.
Ueda told the press conference on Wednesday that he feels "sorry" that the high inflation rate has been forcing households to shoulder increased burdens. The central bank is in close contact with the government, he added.
The BOJ's policy decision sent the yen surging beyond 150 to the U.S. dollar, moving further away from the 161 zone it traded in early July, an over 37-year low, before Japan intervened in the market to prop it up.
A panel of experts led by Japan's top currency diplomat, Masato Kanda, who left the post on Wednesday after overseeing massive yen-buying operations in recent years, has pointed out that Japanese investors have been changing their investment stance in search of higher returns overseas. Yen selling by such retail investors was one of the factors behind the currency's fall.
"We need to be mindful...that bond yields in Japan will be pushed higher by both domestic and foreign investors seeking higher returns," the panel said, warning of the risk that the government will not be able to continue selling bonds with low yields.
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