By Leika Kihara
TOKYO (Reuters) -The Bank of Japan must raise interest rates if persistent increases in food costs lead to broad-based inflation, Governor Kazuo Ueda said on Wednesday, signalling the bank’s resolve to continue weaning the economy off monetary support.
Ueda said Japan’s recent “very high” inflation was driven mostly by temporary factors such as rising import costs and food prices, which are likely to dissipate and thus not a reason to tighten monetary policy.
But there is a chance that sustained rises in food costs could push up prices for other goods and services, he said.
“If such moves lead to broad-based inflation across the economy, we must respond by raising interest rates,” Ueda told parliament.
Ueda also said the BOJ will take “stronger steps” to whittle down monetary support if inflation overshoots its projections, signalling the chance of hiking rates sooner or more aggressively than initially expected.
Japan’s core consumer inflation hit 3.0% in February and has exceeded the central bank’s target for nearly three years, with recent rises driven largely by steady gains in food prices.
The BOJ has stressed the need to focus on underlying inflation, or the long-term price trend that strips away the effect of temporary factors, in deciding the timing and pace of further rate hikes.
Ueda said underlying inflation, which the BOJ determines by looking at various indicators, is heading towards but remains “just a bit” short of 2%.
“We expect underlying inflation to gradually converge toward 2% even when temporary rises in food prices disappear,” as a tightening job market and improvements in the economy lead to sustained rises in wages and inflation, Ueda said.
“We are always vigilant to the possibility that underlying inflation could accelerate at a pace faster than we expect,” Ueda said.
The impact of rising food prices on underlying inflation will likely be a key point of debate when the BOJ’s board issues fresh quarterly economic projections at its next policy meeting on April 30-May 1.
OVERSEAS UNCERTAINTIES
Another complication is U.S. President Donald Trump’s tariff policies, as higher levies on automobiles could deal a huge blow to Japan’s export-reliant economy, analysts say.
While prospects of higher wages will likely underpin consumption, the BOJ must also scrutinise how growing overseas uncertainties could affect consumer confidence, Ueda said.
The yield on the benchmark 10-year Japanese government bond (JGB) briefly hit 1.585% on Wednesday, the highest level since October 2008, due in part to market expectations of further rate hikes by the BOJ.
In judging whether underlying inflation is on course to hit 2%, the BOJ is focusing particularly on whether wages will keep rising at the current pace of around 3%, Ueda said.
“What’s important is for wage gains to be sustained and broaden,” Ueda said, stressing the need to scrutinise whether bumper pay hikes offered by big firms will spread to smaller firms.
“It’s also important for wage gains to be properly reflected in services prices” and heighten long-term inflation expectations, he said.
A leading indicator of Japan’s service-sector inflation hit 3.0% in February, data showed on Wednesday, keeping alive expectations of further BOJ rate hikes.
The BOJ raised its short-term policy rate to 0.5% in January on the view Japan was on the cusp of sustainably achieving its 2% inflation target backed by solid wage gains.
Ueda has said the central bank will keep raising interest rates if prospects of higher wages lead to broader price hikes, not just for goods but also for services.
A Reuters poll this month showed many analysts expect the BOJ’s next rate hike to come in the third quarter, most likely in July.
(Reporting by Leika Kihara; Editing by Christopher Cushing and Jamie Freed)
