Japan raises rates to highest since 2008 on sustained inflation and rising wages

The Bank of Japan raised key rates by 25 basis points on Friday to 0.5%, taking its key rate to the highest level since 2008, as it seeks to normalize monetary policy amid signs of sustained inflation and rising wages.

The move is in line with expectations from the CNBC survey, in which an overwhelming majority of economists predicted an increase.

The BoJ revealed in its statement that the decision was an 8-1 split, with board member Toyoaki Nakamura disagreeing on the rate increase.

Nakamura said the central bank should only adjust policy after confirming an increase in corporate earnings power from reports that would be released by the next monetary policy meeting.

Following the decision, the Japanese yen strengthened by 0.6% to trade at 155.12 against the dollar, while the country’s benchmark Nikkei 225 the stock index increased slightly.

The yield on 10-year Japanese government bonds rose 2.5 basis points to 1.23%.

The Bank of Japan has long argued that a “virtuous circle,” in which higher wages fuel price growth, was necessary to be able to raise rates.

Before the meeting, senior BoJ officials, including Governor Kazuo Ueda and Deputy Governor Ryozo Himino, had indicated the central bank’s willingness to raise rates.

The BOJ will closely monitor “shunto” wage negotiations and hopes to see “strong wage increases” in fiscal 2025, Himino said in a speech to business leaders on January 14.

In its statement on Friday, the central bank noted that “many opinions were expressed by companies saying they would continue to raise wages steadily during the annual spring wage negotiations between unions and management, after the “heavy salary increases last year”, due to improved salaries. corporate profits and a tight labor market.

Japan Confederation of Trade Union President Rengo said annual wage increases this year are expected to exceed the 5.1 percent achieved last year as real wages continue to fall, Reuters reported.

President Tomoko Yoshino said Rengo was officially seeking wage increases of at least 5 percent in this year’s “shunto” wage negotiations, and was aiming for increases of at least 6 percent for smaller companies. in order to reduce the income gap with workers in large companies.

The BOJ pointed out that as wages continued to rise, core inflation had gradually increased to 2%.

CPI figures released earlier on Friday showed headline inflation rose to its highest level since January 2023, at 3.6% year-on-year, in December. Core inflation rose to a 16-month high of 3%.

The BOJ expects the overall inflation rate to be around 2.5% for its fiscal year ending March 2026, due to factors including higher import prices resulting from the depreciation of the yen.

In a Jan. 21 note, Vincent Chung, co-portfolio manager for the diversified income bond strategy at T. Rowe Price, said that going forward, a rate increase would be followed by “a series of gradual increases, potentially bringing down the policy rate.” to 1% by the end of the year.”

He added that the policy rate could even exceed 1%, as this rate approaches the lower end of the BoJ’s neutral rate range.

In September, BoJ board member Naoki Tamura said the neutral rate “would be at least around 1%”, although the BoJ does not have an official neutral rate forecast.

Chung noted that although Japanese officials have indicated that the yen’s volatility is significant, substantial monetary intervention like last year appears unlikely.

Last July, the yen reached its lowest level against the dollar since 1986, reaching 161.96. Japanese authorities later confirmed that they had spent 5.53 trillion yen, or $36.8 billion, to prop up the yen in July.

Japan has spent more than 15.32 trillion yen ($97.06 billion) to strengthen its currency during 2024.

Chung said U.S. inflation could rise later this quarter and, coupled with sustained economic growth, this could put upward pressure on yields, which could strengthen the dollar and weaken the yen.

“Investors should also consider that with possible major trade policy changes and a Fed pause looming, bilateral risk to growth is likely greater this year than in 2024. Therefore, we expect this “realized volatility of USD/JPY remains high in 2024. 2025,” he said.