Former member of the Bank of Japan, Makoto Sakurai, predicts that interest rates may increase three more times to 1.5% during Kazuo Ueda's term, with the next rate hike window likely in June or July next year.
Although the central bank is moving towards a neutral interest rate (approximately 1.75%), the pace will be constrained by economic and political resistance from both the US and Japan. He warned that aggressive fiscal expansion by the government could exacerbate inflation and damage credibility, triggering yen depreciation and bond market volatility, thereby disrupting the normalization process.
Makoto Sakurai, a former member of the Bank of Japan’s Policy Board, stated on Monday that the central bank might raise interest rates three more times during Kazuo Ueda’s remaining term as governor until early 2028, pushing rates up to 1.5%. He also cautioned that the government’s aggressive fiscal spending plans could backfire by exacerbating inflation.
Makoto Sakurai anticipates that the Bank of Japan's next interest rate hike may occur in June or July next year, at which point the interest rate will rise to 1.0%. The exact timing of the rate hike will depend on the strength of the US economy as well as the latest developments in wages and prices within Japan.
He pointed out that although the Bank of Japan has not publicly commented, internally it may estimate the neutral interest rate level to be around 1.75%. Raising the interest rate to 1.5% would keep it below this level while leaving sufficient room for potential future rate cuts. However, as borrowing costs approach this neutral level that neither stimulates nor restrains the economy, further rate hikes will face greater challenges.
Regarding market volatility, Makoto Sakurai warned that the government’s large-scale spending plans aimed at alleviating cost-of-living pressures could backfire. He argued that the recent yen sell-off is not solely due to interest rate expectations but reflects broader concerns about the erosion of Japan's fiscal credibility due to aggressive fiscal expansion policies, which could lead to surging bond yields and further yen depreciation.
Path Towards a 1.5% Interest Rate
According to Makoto Sakurai’s analysis, the ultimate target for interest rates during Kazuo Ueda’s five-year term ending in April 2028 will be 1.5%. If robust US economic growth continues to support Japan’s economy and domestic inflation remains above the central bank’s 2% target, the Bank of Japan may implement two additional rate hikes in the next fiscal year starting in April 2026.
However, if uncertainties surrounding the US economic outlook intensify and domestic inflation significantly slows in Japan, the central bank might opt for only one rate hike in the 2026 fiscal year, postponing subsequent actions until 2027. Makoto Sakurai noted that while the central bank may wish to resume its previous rhythm of raising rates approximately every six months, it appears concerned about resistance from the executive branch of the government, which may explain Kazuo Ueda’s previously ambiguous communication stance.
Previously, the Bank of Japan raised interest rates from 0.5% to 0.75% last Friday, marking the highest level of borrowing costs seen in three decades and representing a landmark step in Japan’s move to end decades of massive monetary easing. Although Kazuo Ueda stated that the policy rate remains below the lower bound of the neutral rate range (estimated between 1.0% and 2.5%), he did not specify how many more rate hikes would be needed to reach the neutral level.
Political Resistance and Tightening Pace
As interest rates gradually approach the neutral level, the process of policy normalization may become more complex. Makoto Sakurai revealed that the Bank of Japan might have obtained approval from high-ranking government officials, including Sanae Takaichi and Finance Minister Satsuki Katayama, for the decision to raise interest rates to 0.75% at the bank's meeting on Friday.
"As long as the Prime Minister and the Finance Minister give their consent, there should be no problem with the Bank of Japan raising interest rates," Makoto Sakurai said in an interview.
"However, as interest rates get closer to the neutral level, the situation may become complicated."
Further interest rate hikes could attract criticism from reflationist advisors under Sanae Takaichi, making subsequent policy adjustments subject to greater political maneuvering.
Fiscal stimulus may exacerbate inflation risks
Japan’s inflation rate has exceeded the central bank’s 2% target for nearly four consecutive years, with companies continuously passing on rising raw material costs to consumers while persistently increasing wages to address labor shortages. Makoto Sakurai pointed out that the Bank of Japan’s Tankan survey shows that businesses expect inflation rates over the next one, three, and five years to reach 2.4%, indicating that inflation is gradually taking root in Japan’s economy.
Against this backdrop, although the large-scale spending plan introduced by Sanae Takaichi’s administration aims to cushion the impact of rising household living costs, it carries the risk of accelerating inflation. Makoto Sakurai warned that the administration’s expansionary fiscal policies might undermine market confidence in Japan’s fiscal situation.
He specifically mentioned that even after the Bank of Japan’s rate hike in December, the yen continued to weaken, suggesting that the currency’s softness is more driven by market concerns about Japan’s fiscal policy. Such concerns about fiscal discipline could trigger a sharp rise in bond yields and an undesirable decline in the yen’s exchange rate, thereby offsetting the monetary policy efforts aimed at stabilizing prices.
Editor/melody