Global Market: BOJ may shift to inflation-fighting mode by December, says former official Watanabe

Bank of Japan (BOJ) could move away from its current tolerance of rising prices and adopt a more aggressive inflation-fighting stance as early as December, potentially accelerating the pace of interest rate hikes, according to Tsutomu Watanabe, a former central bank official and an expert on Japan's price trends, Reuters reported.

Watanabe, an emeritus economics professor at the University of Tokyo, said Japan is facing a third wave of inflation, this time driven by the Middle East conflict. The first wave was triggered by the Russia-Ukraine war, while the second came from domestic wage increases and higher rice prices, he said in an interview on Wednesday, according to Reuters.

The latest inflation wave is expected to be milder than previous episodes, with consumer inflation excluding fresh food and fuel likely to peak near 3% around March next year before easing toward the BOJ's 2% target, Watanabe said.


However, he warned that underlying inflation pressures are becoming a bigger concern, with price trends moving closer to the central bank's target. A tight labour market, rising wages and stronger inflation expectations are contributing to persistent price pressures, he added.

Watanabe said the BOJ may need to reconsider Governor Kazuo Ueda's cautious approach of gradually raising interest rates while allowing inflation to strengthen. With underlying inflation gaining momentum, the central bank's focus may need to shift from supporting price growth to actively containing it, he said.

Based on his analysis of price data, Watanabe estimated that underlying inflation could rise to around 2.2% by July next year if the BOJ continues with its current slow pace of monetary tightening. Such an outcome could force the central bank to implement sharper rate increases later, something policymakers would prefer to avoid, he said.

The timing of any policy shift will depend heavily on next year's wage outlook. Watanabe said uncertainty surrounding the Middle East conflict could lead some companies to delay pay increases, but if labour unions and business groups indicate that wage growth will remain broadly in line with recent years, the BOJ could shift into a more aggressive inflation-control mode by December.

Under such a scenario, the BOJ could raise interest rates once every quarter instead of its current pace of roughly twice a year, Watanabe said.

BOJ Faces New Inflation Challenge

After decades of battling deflation through ultra-loose monetary policy, the BOJ ended its era of massive stimulus in 2024 as external supply shocks, including the Ukraine war, and stronger wage growth pushed inflation above the central bank's 2% target.

The BOJ has raised interest rates several times, including in June, but its policy rate remains at 1%, keeping real borrowing costs negative as consumer inflation stays around 2%.

Watanabe, who has authored several books on Japan's price dynamics, said the country faces a difficult challenge in managing inflation after years of focusing primarily on defeating deflation.

He noted that the BOJ has limited experience in combating sustained inflation, and the slow pace of rate increases has raised questions in financial markets over whether the central bank has the determination to keep inflation under control.

According to Reuters, Watanabe said the BOJ's previous success was in moving inflation expectations away from a zero-inflation mindset, but the next challenge will be ensuring inflation remains anchored around the 2% objective.