Kazuo Ueda’s cautious rate hike signals a new era for Japan’s monetary policy

TOKYO: Kazuo Ueda seems to have adopted a New Year’s resolution aimed at minimising surprises – and the consequent repercussions that typically follow. Following his unexpected moves in July that startled investors, the Bank of Japan governor required Friday’s interest rate increase to be anything but shocking. In this regard, he has succeeded.

The quarter-point hike, raising the main rate to 0.5%, was likely the most anticipated increase of this century. Over the past two weeks, multiple hints from speeches and leaks suggested a tightening was on the horizon, barring an unexpected decision from US President Donald Trump targeting Japan. Even the government, weakened after a recent electoral setback, approved of the change. This was a stark contrast to six months ago when the bank raised rates unexpectedly and adopted a hawkish tone.

However, navigating the future will be more complex, both in terms of content and communication. Ueda made it clear upon his appointment two years ago that his primary aim was to conclude the ultra-easy monetary policy that characterised the previous decade – without steering towards a truly restrictive approach.

The first objective was simply to elevate rates above zero, which the BOJ managed to achieve without significantly disrupting the markets or the economy. The subsequent goal was to gradually raise borrowing costs and reduce the extensive bond purchases that kept long-term interest rates at near-zero levels.

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This required careful communication, something the bank struggled with in July. The misstep then was not with the rate hike itself, but the unexpected nature of it and forceful forward guidance. This miscalculation was considered a major factor in the stock market slump that followed.

Friday’s announcement reiterated the hawkish guidance from July—indicating that if economic conditions permit, the BOJ would continue to raise interest rates and adjust the level of monetary accommodation.

It also included an important caveat about the stability of global markets, which followed promises from officials in August that the bank would refrain from hiking rates during turbulent market periods. The events of this summer likely serve as a critical lesson for Japan’s current officials. The message now should be delivered with caution.

Notwithstanding last year’s downturn, Ueda has thus far accomplished what his predecessors were unable to do: guide policy upward without causing significant harm to the broader economy. However, his role is more challenging than that of many of his counterparts. He must maintain a supportive policy stance while also considering the likelihood that Japan’s economy may have contracted in 2024, as well as ensuring that deflation is truly a thing of the past (the government has yet to officially declare the end of the deflationary period).

The pressing question is how high interest rates can or should rise. Ueda has remained circumspect about the neutral interest rate—the level at which monetary policy neither aids nor impedes economic activity.

As the bank continues to raise borrowing costs, the situation becomes increasingly complex. “The closer we get to the neutral rate, the more we need to consider various factors and evaluate whether further interest rate increases are warranted,” Ueda remarked in December. This is further complicated by the bank’s admission that it is uncertain where the neutral rate lies. If too aggressive, and the rate surpasses that neutral level, he risks undermining all the progress made so far.

Ultimately, the BOJ can only move as far as the broader economy can withstand, both in terms of the peak level for rate increases and the pace at which those hikes occur. The most insightful central bankers have understood for some time that the more the public is prepared for their actions, the more flexibility they possess. Ueda’s cautious approach is well-founded.