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More famously known as the Kuroda Group, Japan’s new team of monetary policymakers has recently gone for the jugular in daring monetary policy measures and implemented historic decisions such as raising its interest rates to a level not seen since the 2008 credit crunch. On Friday the central bank raised its short term benchmark lending rate from 0.25% to 0.5% amid a sense of improving economic outlook and belief that the country can support inflation at the BOJ’s targeted 2%. This is a first rate increase since July of last year and a big shift from the previous battle with deflation which the BOJ previously faced for decades.

This decision reinforces the ECB’s assumption that the growth in wages and persistent inflation will be a solid ground for future economic growth. But it also includes risks associated with changes in conditions at the world economy, trade, and the market.

The BOJ’s Confidence about Persistency of Inflation and Wage Increase

In the news, BOJ Governor Kazuo Ueda said on Friday after the two-day policy meeting that he has a bright outlook on Japan’s economy. He said that monetary policy target of the central bank is still to continue with the gradual tightening of interest rates amid broader based wages and prices in Japan.

“During this year’s annual wage negotiations, many firms have indicated they will continue to steadily raise wages,” Ueda said, as more business entities are expressing optimism in an inflation-wage-consumption cycle.

The recent BOJ quarterly outlook report adjusted inflation expectations higher and expect core inflation to remain at 2% or above for three years consecutively. Shortage of labour, inflationous picture depicted by food price and fuel price and a low yen have put a pressure on this inflation.

Central Bank Hikes Interest Rate as a Signal of Confidence but Causes Doubts about the Main Policy

Friday’s decision to raise the policy rate to 0.5% is the highest seen in seventeen years. The decision was made with the support of eight members and opposed by only one board member, Toyoaki Nakamura. But Governor Ueda provided relatively little information about how the pace and timing of future increases would unfold.

“Now, it is not set,” Ueda said. That means: “We shall decide at each policy meeting based on economic and price and other risks.”

Ueda also pointed out that the current status of the policy rate and the neutral rate in Japan was quite wider. Current estimates of Japan’s neutral rate is at 1% to 2.5% with most experts more inclined toward the lower end of the scale.

The fact remains that this allows for future monthly rate adjustments to be incremental. ‘When rates approach neutral, or slightly above neutral, there will be some response to the economy like the decline in housing investment,’ said Ueda. We will attempt to respond before the effect is big.” But we will be gradually feeling the water.”

Economic Context: Inflation and a Weak Yen Driving Change

Japan has had a terrible time for more than 20 years now resulting to stagnated economy, deflation and slow economic growth but things are slowly, slowly turning around. Japan’s core consumer inflation rose in December to 3.0% YoY, the highest in the last 16 months as fuel and food prices soared.

Moreover, a higher level of wages has also supported the BOJ’s optimism about its policy change. Commitment to higher wages, to boost spending more to sustain the inflation rate is essential for Japan.

However, the element that has caused somewhat mixed aspect in the economy is the relatively weak yen. After BOJ’s move, yesterday the yen strengthened as much as 0.8 percent to 154.845 per dollar, but fell after Ueda news conference. On the same note, the yield on the benchmark two-year Japanese government bond or JGB rose to a 2-year high of 0.725% from a previous of 0.62% ahead of this year’sConsumer Price Index data release.

Global Implications: Uncertainty Amid U.S. and Global Shifts

Thus, while the BOJ’s policy change reads domestic confidence, those external risks remain high. Ueda also pointed out such factors as potential fluctuations within the U.S. economy under the Trump administration, including tariffs and further cuts in interest rates by the Federal Reserve of the United States.

Different information indicating that the American economy is in a healthy state has been produced. ‘Markets have been stable as the broad course of Trump’s policies is now emerging,’ said Ueda. But he said that there is still a lot of uncertainty about potential increases in tariffs and their effect on world trade and the Japanese economy.

The BOJ has also pared back a part of its forward guidance that once urged people to pay close attention to risks associated with overseas economy and markets, the bank’s confidence on a solid U.S. growth and its support to Japan’s economy in the near term.

Market Reactions and Analyst Predictions

After the announcement from BOJ, the markets did not move much as the investors did factor in the final hike of one more 25 bps before the end of the year. “Their logic remains the same. They are still far from neutral so they had to make an adjustment, commented Naka Matsuzawa, chief macro strategist at Nomura Securities in Tokyo.

But Matsuzawa also pointed out that unless the BOJ raises its forecast for the neutral rate to something much higher than its current estimated level of around 1%, there may be little scope for further increases in the near term.

BOJ watching economists such as Saisuke Sakai of Mizuho Research & Technologies armed with their great professional knowledge believe that the BOJ will act slowly and gradually, increasing rates perhaps every half a year. “The next increase is expected to be in the third quarter of the current fiscal year ending in March 2016 and the next in the first quarter of the next fiscal,” Sakai said.

Looking Ahead: Gradual Tightening and Uncertain Terrain

Like the rest of the BOJ, Governor Ueda’s approach to rate hikes is optimistic and cautious. Since assuming the position of governor in April 2023, Ueda has started the process of slowing down the pace of easing implemented before him by raising rates while indicating that they no longer seek to stimulate growth beyond the country’s true potential.

To be specific, there has recently been much confirmation among BOJ policymakers about the fact that they are going to continue tightening if Japan is going to maintain its pace within enhancing an inflation rate-wages-consumption cycle. Nevertheless, they are still cautious about which external factors may cause distortions: fluctuations in international commerce, increase in the tariffs for imported goods, internal issues, like the deterioration of domestic investment in areas including housing.