BOJ’s Ueda Cites ‘Uncertainty’ on Future Rate Hikes as Neutral Rate Remains Elusive

AsianForexHub Market Pulse

• BOJ Gov. Ueda confirmed some uncertainty regarding the number of future rate hikes, pending conclusion on the ‘neutral rate’.
• Ueda’s recent remarks spurred expectations for a rate hike at the Dec. 18-19 meeting.
• 10-year JGB yield hit 1.920%, the highest level since July 2007.
• Markets are potentially pricing in a terminal rate of 1.5%.
• Wage growth momentum is a key factor in the BOJ’s policy decision.

The timing of Japan’s next shift in monetary policy appears to hinge on a hard-to-pin-down detail that fascinates economists: the so-called neutral level of interest rates. Bank of Japan Gov. Kazuo Ueda on Thursday said officials at the central bank are working to narrow a range for the neutral rate—the level viewed as consistent with economic stability.

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Central Bank Focuses on Elusive Neutral Rate

Such a decision will help inform the bank whether it needs to tighten policy more as it assesses economic data. Figuring out what the neutral rate looks like is a tightrope many central banks are trying to walk, and the BOJ’s deliberations have implications for global markets. The neutral rate is the level that keeps the economy at full employment with stable inflation, but it can’t be directly observed. Instead, policymakers infer it from economic behavior. If borrowing and spending are strong and price pressures are rising, the current rate must be below neutral.

On Thursday, the BOJ’s Ueda used an appearance before a parliamentary committee to state that officials hadn’t reached a conclusion on the neutral rate. This served as a signal to markets that it is unclear when Japan’s tightening cycle will come to an end.

‘Some Uncertainty’ on Terminal Rate

“The final decision on how high to raise the nominal interest rate appropriately depends on this factor, so I must mention there is some uncertainty,” Ueda said. He added that the BOJ will share its findings once it reaches a conclusion.

Remarks from Ueda earlier this week sharply increased expectations that the bank will resume monetary tightening at its next meeting on Dec. 18-19. This has led to a jump in yields on government debt and a rebound in the yen. The yield on benchmark 10-year Japanese government bonds reached 1.920% on Thursday, the highest level since July 2007. The yen was last trading at around 155.50 against the dollar. Daiwa Securities strategist Eiichiro Tani suggested markets have almost priced in a potential terminal rate of 1.5%.

Ueda previously pledged to discuss the pros and cons of raising the policy rate from the current 0.5% and make the appropriate decision at the upcoming meeting. One of the most important factors in the BOJ’s decision-making will be early signs on the strength of pay hikes next year. Ueda also reiterated that current monetary conditions in Japan are still accommodative, suggesting that policy will continue to support the economy even if the bank opts to raise interest rates.

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