BOJ Governor Ueda says underlying inflation 'quite close' to 2% target

Bank of Japan Governor Kazuo Ueda stated on Monday that Japan's underlying inflation is nearing the 2% target that the central bank aims for. Ueda further explained that if the Bank of Japan raises its short-term policy rate, long-term interest rates will likely increase gradually in line with that policy change. Achieving and maintaining an underlying inflation rate near the 2% target is becoming increasingly important because it anchors core inflation.

Japan is currently experiencing a positive loop of rising wages, recovering prices, and other inflation pressures. The Middle East conflict is driving up energy and supply-driven inflation, while strong global demand is pushing up domestic capital expenditures, exports, and prices for various goods as a result of demand-based inflation.

Japan's steady economic recovery, tight labor market, and robust global demand are all contributing to inflationary pressures. Despite these factors, the BoJ has not changed its fundamental bond tapering approach and has not announced any pre-emptive measures for emergency bond market interventions. The central bank will review market conditions, including the pace of long-term rate increases and any signs of market instability, before deciding on any necessary interventions.

If the Bank of Japan raises its short-term policy rate, long-term interest rates are expected to rise steadily alongside it. Financial conditions remain accommodative at present. Failing to adjust the policy rate appropriately could lead to market concerns about inflation risk, which could, in turn, increase long-term rates. By implementing monetary policy correctly to reach the 2% inflation target, the BoJ can help stabilize Japan's government bond (JGB) market.

Fiscal spending that supports demand, raises prices, and wages, and expands Japan's supply capacity can also help tame inflation over time. As of the writing of this report, the USD/JPY currency pair is down 0.13% for the day, trading at 157.80. Ueda's 7/10 FXS Speechtracker score is slightly below its 7.4/10 historic average, but the emphasis on "underlying inflation near 2%" and a "positive loop" of wages and prices indicates a mildly hawkish shift compared to Japan's past disinflation narrative.

The focus on anchoring core inflation at 2%, combined with the robust global demand supporting exports and capital expenditures, and the tight labor market fueling inflation, all support a gradual move away from ultra-loose monetary settings. This moderate hawkish shift is generally supportive for the Japanese Yen. However, Ueda stresses that there will be no change in the central bank's fundamental bond tapering approach and vows to avoid preannouncing emergency bond measures, signaling caution and a desire to avoid destabilizing the JGB market.

The message from the Bank of Japan is that properly calibrated rate hikes would allow long-term yields to rise "steadily" while maintaining financial conditions that remain accommodative. This suggests a controlled normalization path, which limits the upside potential for the Yen in the near term but reinforces a slow, hawkish-leaning bias over the medium term.

The BoJ is the Japanese central bank, responsible for setting monetary policy in the country. Its primary mission is to issue banknotes and carry out currency and monetary control to ensure price stability, which means maintaining an inflation target of around 2%. The Bank of Japan began an ultra-loose monetary policy in 2013 to stimulate the economy and fuel inflation during a period of low inflation.

The bank's policy is based on Quantitative and Qualitative Easing (QQE), which involves printing money to buy assets such as government or corporate bonds and provide liquidity. In 2016, the Bank of Japan intensified its strategy by further loosening policy by introducing negative interest rates and directly controlling the yield of its 10-year government bonds.

In March 2024, the BoJ raised interest rates, marking a retreat from the ultra-loose monetary policy stance. This shift in policy caused the Yen to depreciate against its main currency peers, with the process accelerating in 2022 and 2023 due to a widening policy divergence between the BoJ and other major central banks. These central banks opted to increase interest rates sharply to combat high inflation levels.

The BoJ's policy led to a widening differential with other currencies, causing the value of the Yen to decline. However, this trend partially reversed in 2024 when the BoJ decided to abandon its ultra-loose policy stance. A weaker Yen and the surge in global energy prices contributed to an increase in Japanese inflation, which surpassed the BoJ's 2% target.

The prospect of rising salaries in Japan – a key driver of inflation – also played a role in this trend. Lallalit Srijandorn, a Parisian at heart, has lived in France since 2019 and now works as a digital entrepreneur in Paris and Bangkok. The USD/JPY pair is currently down slightly on the day, trading at 157.80, while the USD/JPY FXS Speechtracker score remains slightly below its 7.4/10 historic average.

The report highlights a mildly hawkish shift in Ueda's remarks, which could potentially support the Japanese Yen in the medium term.