Caught between growing voices in Europe for a rate hike and domestic politicians pressuring against it, the Bank of Japan raised its benchmark interest rate to 0.50 percent Wednesday.
BOJ Gov. Toshihiko Fukui signaled the impending rate hike from 0.25 percent, and the decision prevailed in an 8-1 vote by the Policy Board. BOJ Deputy Gov. Kazumasa Iwata, a former senior official of the Cabinet Office, was the lone dissenter.
It was the first time a deputy governor voted against a governor’s proposal since the central bank began to operate under the new BOJ Law established in 1998.
The BOJ also decided to raise its basic loan rate — the short-term interest rate for banks borrowing from the central bank — from 0.40 percent to 0.75 percent. Both rates became effective immediately.
As for long-term government bonds, the BOJ said it will continue to buy about 1.2 trillion yen worth of bonds a month to help keep the interest rate from increasing.
Iwata opposed the proposal, arguing that the outlook for prices was still unclear, according to BOJ Gov. Toshihiko Fukui.
The government did not execute its right to ask the BOJ Policy Board to postpone the rate hike. Ahead of last month’s meeting, Liberal Democratic Party politicians claimed the government should step in to delay a rate hike, which did not happen then.
Speaking later Wednesday, Fukui hinted that the central bank took into consideration rising criticism from European leaders against Japan’s monetary policy.
“We need to thoroughly put in mind the external consequences when we reach a conclusion on monetary policies,” Fukui said. “We need to expand our vision globally in carrying out monetary policies.”
Although Fukui said the yen-carry trade, in which investors borrow yen funds at a low interest rate and then invest them in higher-yielding assets denominated in such currencies as the dollar, wasn’t a decisive factor in Wednesday’s decision, he voiced concern over the increasing trade.
“If there is too much concentration of resources due to the yen-carry trade in the currency market, it is likely to have a negative effect on the economy and prices in the future,” Fukui said.
The yen-carry trade has become popular due to Japan’s extremely low interest rates, increasing the risk of volatile movements in financial markets as investors unwind their positions.
Fukui added he will consider further boosting the interest rate in a “slow manner” after carefully analyzing the economy and prices.
In a statement, the BOJ said the economy is likely to continue expanding moderately and uncertainties over the prospect of the U.S. and other economies are fading.
“If (the public) continues to believe that the interest rate continues to remain low regardless of the economy and prices, sustainable economic growth may be hampered because of excessive financial and economic activities,” the statement said.
The BOJ also said private consumption is moderately increasing, adding that weak indicators of private consumption last summer had been temporary. The BOJ had refused to raise the interest rate in past meetings because of weak private consumption.
Commenting on a future rate hike, the central bank said it will maintain the rate at a low rate “for some time” and adjust it in accordance with economic and price conditions.
Daiwa Securities SMBC senior economist Yasutoshi Nagai said that any further rate hike would be unlikely until after the July Upper House election, and even then any additional rise would not exceed 0.25 percent.
“(The BOJ) said it wanted to take this slowly,” said Nagai, adding that Wednesday’s rate hike would have few immediate repercussions.
“This was something already expected,” Nagai said. “The short-term rate hike was small to start with, so I think the impact on the real economy will be almost nil.”
The central bank has been caught between growing criticism from Western countries that its low interest rate is causing a weaker yen and damaging their economies, while politicians in Japan claim the economy is still not strong enough to raise the interest rate.
Masatoshi Moriyama, senior economist at Mitsubishi UFJ Research & Consulting Co., said a combination of factors both domestic and international gave the BOJ only a small window of opportunity to raise the rate.
Within Japan, he said, recent GDP figures were judged good enough to justify a hike now.
The economy grew 1.2 percent in the October-December period from the previous quarter thanks to a rebound in personal consumer spending.
Meanwhile, he added, BOJ officials likely calculated that the political mood would turn against a rise during the leadup to the Upper House election.
“They were down to the wire,” said Moriyama, explaining that failure to act now could have presented an image of succumbing to government pressure to keep the rate low.
“There would be a loss of faith in the Bank of Japan; the market would start ignoring its signals,” Moriyama said. “Considering the loss of faith and the questions that would arise over its degree of independence, if this chance was missed, there was a risk that the bank would face trouble down the line setting policy.”
Moriyama noted the pressure from Europe to increase the overnight call rate — a move that, if followed by other confidence-building hikes, would encourage a shift into yen-denominated savings and bonds and thus a rise in the yen itself against the euro.
Pressure from the U.S. could also be expected, he said, as a Congress controlled by protectionist Democrats demanded Japanese efforts to staunch further drops by the yen.