(CORRECT) MNI INTERVIEW:Ex-BOJ's Yamamoto Urges Gradual Hikes

*The article headline has been corrected to change “swift hikes” to “gradual hikes.”

The Bank of Japan has already fallen behind the curve, but will be forced to raise the 0.75% policy rate in gradual 25 basis-point increments to protect the economy and financial markets, former BOJ executive director Kenzo Yamamoto told MNI, declining to comment on timing.

Yamamoto, now head of the KY Initiative, said gradual hikes were required, rather than 50bp or 75bp increases, despite the current 0.75% policy rate being too low relative to the 2.5% CPI rate excluding fresh food and institutional factors, which has remained above 2% since February 2022.

While the BOJ faced a difficult balancing act between upside inflation risks and downside economic risks, it primarily needed to contain inflation expectations unless the economy experiences sharp fluctuations, he argued. Rapid rate hikes could also destabilise the economy and financial markets, despite the BOJ already having fallen behind the curve, he said.

Yamamoto has previously called for quarterly rate hikes. (See MNI INTERVIEW: Ex-BOJ's Yamamoto Urges Quarterly Hikes) Markets assign a 80% probability to a 25bp increase at the next June 15-16 meeting and price in a policy rate of 1.22% by December.

While the BOJ has regarded trimmed mean, weighted median and mode — all of which have a downward bias — as measures of underlying CPI inflation, the year-on-year increases in those indicators have slowed recently, making it difficult for the Bank to continue treating them as measures of underlying CPI inflation.

“The BOJ in late March released new CPI data excluding institutional factors, which are favourable for raising the policy rate,” he noted, adding the Bank will not use underlying CPI inflation in future.

JGB REDUCTIONS

Yamamoto also said the BOJ should not suspend reductions in JGB purchases and should clarify the common ground regarding the size of the balance sheet it aims to achieve in future.

He added that if the Bank were to suspend reductions in its Japanese government bond purchases, it would be unable to reduce its holdings to what it considers an appropriate level, making it difficult for the Bank to resume scaling back JGB buying at a later stage.

The BOJ will review and decide at the June meeting on the pace of JGB purchase reductions from April-June 2027 onward. The bank has already decided to reduce purchases by around JPY200 billion per quarter until Q1 2027, bringing monthly JGB buying to JPY2.1 trillion.

Yamamoto calculated that if the BOJ maintains the current pace of reducing JGB purchases by JPY200 billion per quarter, the balance of long-term JGB holdings would fall to around JPY110 in fiscal 2035, close to the balance of banknotes in circulation, projected at JPY116 trillion as of May 10. Those simulations would need to be recalculated and the estimates or simulations can change, depending on preconditions, Yamamoto noted.

The BOJ temporarily suspended the so-called banknote rule in April 2013 — which restricted JGB purchases to within the value of banknotes in circulation — to implement aggressive JGB buying, but the rule formally remains in place.