MNI POLICY: BOJ To Keep Neutral, Terminal Rate View

The Bank of Japan will maintain its current 1-2.5% estimated range for the neutral interest rate following the next hike widely expected at the Dec. 18-19 meeting, and will continue to assess whether its policy rate remains appropriately accommodative using indicators such as bank lending, the Tankan survey and capital investment, keeping the door open for further rate hikes, MNI understands.

Recent comments by Governor Kazuo Ueda, who said the bank would consider clarifying the distance from neutral after the next rate increase, have fueled speculation that the bank might narrow the current neutral rate range to counter the view that the BOJ would face limits in raising rates after lifting the policy rate to 0.75%. (See MNI POLICY: Ueda Sharpens Dec Rate Hike, Risks Credibility)

Market participants, however, may have misinterpreted Ueda's comments as signaling a radical policy shift. Concerns about a rising low end of the neutral rate and a higher terminal rate, which the bank also cannot pinpoint, have added upward pressure on JGB yields, and driven concern at the BOJ regarding any update to its neutral estimate. (See MNI POLICY: BOJ Frets Over Neutral Rate Update)

The Bank does not view the lower end of its neutral interest rate range as a target, nor does it consider it the terminal rate. Officials see the neutral rate as a conceptual range rather than a specific level, and say its position cannot be known in advance. Instead, the bank must monitor how the policy rate affects the economy, inflation and overall financial conditions.

POLICY TOOL

Like the Federal Reserve and the European Central Bank, the BOJ cannot precisely identify either the neutral rate or the terminal rate because both move gradually. Nevertheless, the bank continues to use the neutral rate as a communication tool to explain its policy framework, despite it not being directly tied to policy decisions.

The neutral rate is derived from the natural interest rate plus the expected inflation rate of around 2%, but estimates based on six different models produce a wide range. The current estimate was released in 2023 based on data up to September 2019, and officials may review it as new data becomes available.

The BOJ is also considering whether a gradual rise in potential economic growth could increase the natural rate, though the impact on the neutral rate is likely limited. The BOJ is also focusing on total factor productivity (TFP), another determinant of potential growth, but this is difficult to calculate accurately. Officials are unlikely to revise estimates immediately, as revisions to GDP data could alter calculations of potential growth and the economic gap.