The International Monetary Fund says the Bank of Japan may need to accelerate interest-rate increases if inflation proves stronger than policymakers currently expect.
Krishna Srinivasan, director of the IMF’s Asia and Pacific Department, said the BOJ is taking the correct approach by normalizing monetary policy.
But he said the pace could need to increase if inflation surprises to the upside because policymakers need to prevent inflation expectations from becoming unanchored.
Japan’s policy rate is already at 1.25% after the BOJ raised borrowing costs in September to their highest level in more than three decades.
The shift marks a fundamental break from the extremely loose monetary conditions that defined Japan for much of the post-financial-crisis era.
Bank of Japan Governor Kazuo Ueda has reinforced that shift, with policymakers focused on anchoring underlying inflation around the central bank’s 2% target.
Inflation pressure has been reinforced by expensive imported energy and a weak yen.
At the same time, rising Japanese government-bond yields are increasing scrutiny of the country’s fiscal position.
The IMF has urged Japan to establish a medium-term fiscal framework capable of strengthening confidence in debt sustainability.
For markets, faster BOJ tightening could affect much more than Japanese borrowers.
Japan has been an important source of low-cost global capital for decades. Higher domestic yields can encourage Japanese investors to keep more capital at home while making yen-funded carry trades less attractive.
The next signals will come from Japanese inflation data, the yen and BOJ communications about the pace of normalization.
