TOKYO, Dec 4 — Bank of Japan (BOJ) chief Kazuo Ueda used diplomacy and nodded to the dangers of inflation and a weak yen to sell his plan for a December rate hike to Prime Minister Sanae Takaichi, who called rate hikes "stupid" only last year.
The pitch worked: both markets and Japan's new government got the message that a quarter-point rate hike to 0.75 per cent later this month was a near certainty, allaying worries the BOJ might succumb to political pressure to not tighten policy.
However, what is less clear is how the BOJ plans to communicate the longer-term rate hike path, a more challenging task given a lack of consensus on where Japan's neutral rate of interest lies.
The uneasy truce between the BOJ and the administration will keep the bond market jittery, with investors already focusing on what Ueda will say about the pace of further rate hikes.
"I think the BOJ sees a December hike pretty much as a done deal. The more important question is what is next.
"The yen will fall if Ueda fails to assure markets that the BOJ will keep hiking rates. But signalling steady hikes could make the administration nervous
"It is tricky," said Nomura Securities executive rates strategist Mari Iwashita.
First round to the hawks
Ueda essentially pre-announced a December rate hike in a speech on Monday (December 1), saying the BOJ would consider the "pros and cons" of such a move this month.
The comments, which led markets to price in an 80 per cent chance of a December hike, drew little pushback from the Takaichi administration, which has historically advocated loose monetary policy.
Instead, on Tuesday (December 2), Finance Minister Satsuki Katayama said she saw no problem with Ueda's comments, a sign the government will not get in the way of a rate hike this month.
Even Takaichi's reflationist aides gave guarded consent, including government panel member Toshihiro Nagahama, who said the premier may accept a December hike if the yen stayed weak.
"The BOJ will have to raise rates if the yen's weakness persists even after next week's United States monetary policy decision," he told Reuters when asked about Ueda's speech on Monday.
The next hike would bring the BOJ's policy rate to 0.75 per cent, a level unseen in three decades, as another step by Ueda to remove remnants of his predecessor's radical stimulus.
Clearing political opposition has been the biggest challenge to Ueda's rate-hike plan since Takaichi took office on October 21, with the premier voicing displeasure over an early increase.
However, as with Ueda's past two rate hikes, fears of unwelcome yen depreciation helped the BOJ convince politicians of the need to lift the profoundly negative real interest rates.
The breakthrough came in Ueda's meeting with Takaichi on November 18, held at the premier's office late afternoon rather than the customary one-hour talk over lunch.
Describing the meeting as "candid, good" talks, Ueda said Takaichi acknowledged the BOJ's plan to make a smooth landing towards its price goal through gradual rate hikes.
A day later, Katayama met Ueda and said she had no objection to a gradual "adjustment" of a still-massive stimulus.
By then, the yen was at 10-month lows, drawing threats of currency intervention by Katayama. The premier no longer argued that the government, rather than the BOJ, sets monetary goals.
"The premier is very sensitive to yen moves," said a government official with knowledge of the administration's deliberations.
"Countering the weak yen became a priority as inflation would hit approval ratings," another source said.
Laying the political groundwork
Immediately after the talks, the BOJ's monetary affairs staff began crafting rhetoric to prop up market bets of a December hike without antagonising the administration.
Staff burnt the midnight oil to complete a draft speech for Ueda on December 1, the last set event available to drop policy signs before the December 18 to December 19 rate review.
The plan was to praise 'Abenomics', a mix of monetary and fiscal stimulus deployed by former premier Shinzo Abe and hailed by Takaichi, as successfully pulling Japan out of stagnation.
The speech then explained that raising still-low borrowing costs would achieve long-term, stable growth and ultimately "lead to the success of efforts undertaken by the government and the BOJ."
"Ueda's speech shows the BOJ and the administration had done the necessary groundwork," said former BOJ board member Takahide Kiuchi.
'Haste makes waste'
While Japanese law nominally affords the BOJ independence, it has faced political pressure in the past to expand monetary support for a moribund economy.
The central bank is also sensitive to political winds because the government has the authority to pick the governor and members of the board, which then need Parliamentary approval.
Ueda's dogged caution, which had served as a restraining force in an increasingly hawkish board, may have also helped convince the administration that the rate hikes would be gradual.
People who know Ueda well describe him as a pragmatic, cautious academic who prefers to collect and analyse data before making decisions.
"Haste makes waste is probably Ueda's approach. Such a style may have helped dispel worries held by some politicians that the BOJ would rush into normalising policy," said one of them.
But there is uncertainty on how long the truce will last.
Even if the BOJ successfully hikes rates in December, it faces a bigger challenge in communicating how far it would eventually push up borrowing costs.
The BOJ has released estimates suggesting Japan's nominal neutral interest rate, the rate that neither cools nor overheats the economy, lies between one per cent and 2.5 per cent.
Analysts argue that a wide range prevents investors from buying long-term bonds due to uncertainty over future rate hikes.
Today, Ueda acknowledged uncertainty about how far the central bank could raise rates.
Swap rates indicate that markets expect the BOJ to raise rates to around 1.5 per cent by mid-2027 eventually. But one of Takaichi's economic advisers, Takuji Aida, said after a hike to 0.75 per cent, the BOJ should keep rates steady until 2027.
Analysts have noted that the ambiguity complicates communication about future hikes.
"In reality, the BOJ would have to judge whether its rate is approaching neutral by looking at how its rate hikes are affecting the economy and prices," said former BOJ official Nobuyasu Atago.
