MNI POLICY: BOJ Faces Hurdle On Real Rates To Justify Hikes
The Bank of Japan will face challenges in using negative real interest rates to argue that policy remains accommodative and to justify further rate hikes, as real rates could flatten or turn positive, while officials remain reluctant to raise the neutral rate estimate for fear of sparking speculation of rapid rate hikes, MNI understands.
While there is no single “real interest rate” as the BOJ calculates multiple measures, some negative rates could narrow or turn positive as year-on-year CPI growth slows, complicating the case for hikes based on real rates. The BOJ expects core CPI to rise less than 2% in the first half of fiscal 2026, while headline CPI for December is projected to fall below 2% from a 2.0% gain in November.
For example, the real policy rate – calculated as the nominal policy rate minus CPI – would narrow to -0.75% if CPI slows to 1.5% y/y, above the lower bound of the estimated natural rate of interest range of -1.0% to +0.5%, suggesting policy is no longer accommodative.
While the BOJ could theoretically justify hikes using a higher neutral rate, officials consider this unlikely, as it could prompt speculation of rapid tightening. Instead, they are closely monitoring how the December rate increase has affected financial conditions to determine whether an accommodative environment persists alongside developments in real rates.
Officials note that the bank is still some distance from this issue, as real interest rates remain broadly negative across most measures.
However, a slowdown in headline CPI would not necessarily prevent rate increases, as the BOJ manages policy based on underlying CPI inflation.
In December, the bank removed its previous view that underlying CPI was likely to remain sluggish, citing reduced downside risks to the U.S. economy and government measures aimed at boosting private demand, which are expected to improve the output gap and support inflation. (See MNI BOJ WATCH: Ueda Signals More Hikes, Timing Unclear)
