By Leika Kihara

TOKYO, Reuters – Bank of Japan policymakers debate when they should start telegraphing an eventual rise in interest rates. This could happen even before inflation hits its 2% target. Sources say that this is because of broadening prices and a more hawkish Federal Reserve.

A rate increase is unlikely and the BOJ will likely maintain its ultra-loose policy for at least the remainder of the year. However, the financial markets might underestimate the BOJ’s willingness to slowly phase out its radical stimulus program.

Notably, the BOJ’s carefully worded promises to keep monetary policy accommodative apply only to steadily pumping cash into markets – not to keeping rates at current low levels.

According to a source who is familiar with BOJ thinking, “The BOJ has never promised that rates will be held until inflation exceeds 2 percent.” This view was also shared by two other sources.

It can theoretically raise rates even if inflation remains above target.

After nine years’ of aggressive monetary ease, it seems that the BOJ is finally getting what they want. The BOJ is moving closer to its goal of deflation and the public’s perception of it has changed.

The rise in raw material prices is more important than the anticipated uptick of domestic demand. In the near term, the BOJ will try to prevent a temporary blip from inflation and market speculation that would lead to an earlier policy tightening.

A lot of BOJ officials aren’t optimistic that conditions will be in place this year to warrant a rate increase. This is because there is uncertainty about whether consumers will grow enough to permit firms to continue raising prices.

This could mean that an actual rate increase may not occur until 2023, and possibly under the leadership of a new governor to succeed Haruhiko Kuroda (whose term expires in April 2019).

Sources said that the Fed’s rate-hike plan and a weakening yen are pushing the BOJ towards being bolder when it comes to imagining an exit strategy.

According to a second source, “For the first-time in a long time there have been upside as well as downside risks regarding the price outlook.”

A third source stated that the BOJ must pay attention to other central banks’ activities, noting an increase in overseas counterparts looking at rate increases.

Sources said that the nine members of the central bank’s board are split into two camps: those who believe there is scope for reducing stimulus and those who fear taking steps that might be considered as tightening policy.

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Already, the BOJ is gradually tapering its asset purchases to phase out quantitative easing. Its current rate of bond buying is about one-fifth of the 2016 level. In 2016, the BOJ switched to an interest rate policy that was different from money printing. (Graphic: BOJ has steadily ‘stealth’ tapered its JGB buying, https://graphics.reuters.com/JAPAN-ECONOMY/BOJ/byvrjmeoyve/chart.png)

The government is slowing down purchases of risky assets. In March it will end a loan program for coronavirus relief in order to reduce the country’s cash supply.

Because stocks rallied and the trend was towards weakening, the BOJ’s tapering has not surprised markets.

The BOJ would continue to taper asset purchases and shift towards tweaking yield curve control (YCC), which is set at -0.1% short-term rates, and about zero 10-year bond yields.

By flagging rising inflation prospects, the central bank is beginning to signal that forever-zero rates may soon be over.

Kuroda indicated last month that inflation could approach 2% due to rising raw materials costs. This was his strongest signal yet, indicating an increase in price pressures.

Following a statement by Masayoshi, the deputy governor, that inflationary pressures were steadily increasing with more companies being in a position to pass on cost to consumers, this was followed by Amamiya’s comment.

According to sources, the next step is to adjust its guidance regarding the future rate path. This could go beyond the existing pledge to keep rates at “current or low levels”.

It could happen before inflation sustainably reaches 2%.

BOJ says it will increase money printing to ensure inflation stays above 2.2%. However, it does not promise how long they will be able to keep their rate targets current.

A fourth source said that it was clear the intention. “Central banks should allow themselves some flexibility when adjusting rates.”

The sources stated that there are no clear ideas within the BOJ about how to abandon negative rates or widen the implied band in which 10-year yields can move above its 0% target. They also suggested getting shorter duration bond yields.

It is unclear when the BOJ could raise rates. However, expectations are rising that the Fed will increase three times this year.

Years of prodding from the government and aggressive monetary ease haven’t convinced firms to increase their wages.

BOJ also has to consider political considerations.

Japan’s enormous debt pile, twice that of the economy, relies on the BOJ to support it. This is among the most significant in advanced countries. Japan’s finances could suffer a severe blow if there is a slight rise in borrowing costs.

It could also mean that the job of increasing rates will be delegated to the next BOJ governor. Amamiya could be a strong candidate to succeed Kuroda.

According to a fifth source, “If consumers accept price rises more than they are now, then that might allow the BOJ debate increasing rates.” Due to Japan’s enormous public debt, it will be difficult and time-consuming to negotiate with the government.