Bank of Japan Governor Kazuo Ueda on Friday warned of "extremely high" uncertainty over the sustainability of recent inflation and wage growth, as the central bank decided to keep interest rates extremely low to support the economy.
After a two-day policy meeting, Ueda acknowledged that the pace of inflation has been slowing more moderately than expected, underscoring the challenges faced by the BOJ as rising prices of everyday goods put "big burdens" on consumers.
The decision to stand pat, which was widely expected, means short-term interest rates will remain at minus 0.1 percent, while 10-year Japanese government bond yields are guided to around zero percent. The upper cap on the benchmark yield has been set at 0.5 percent since December.
The BOJ reiterated its pledge to "patiently" continue with monetary easing, adding that it will not hesitate to take additional steps.
"There is a possibility that the inflation rate will undershoot 2 percent going forward, so we have not moved toward policy normalization," Ueda told a post-meeting press conference.
Ueda, who took the helm of the central bank in April, has warned of prematurely tightening monetary policy, saying there is still some "distance" to achieving the BOJ's 2 percent target stably and sustainably along with wage growth.
"We are beginning to see changes in how companies set prices and wages, a point we are closely watching. But there is extremely high uncertainty over how things will turn out, including wage hikes," he added.
The dovish stance contrasts sharply with its global peers, which have been scrambling to curb inflation with aggressive interest rate hikes.
This week, the U.S. Federal Reserve decided to pause rate hikes for now, though more increases are in the offing. The European Central Bank went ahead with a 0.25 percentage point increase on Thursday, signaling more to come.
The BOJ will continue to buy 10-year bonds at a fixed rate of 0.5 percent every business day in principle, keeping up its fight to defend the yield cap.
Upward pressure has recently eased on the benchmark yield, but analysts say the BOJ's divergence with the Fed and the ECB is a recipe for a weaker yen, with the currency depreciating against the U.S. dollar after the policy decision.
Ueda, who has stressed the importance of communication with financial markets, said policy decisions should be data-driven and may sometime come as a "surprise."
During his five-year tenure that began in April, he will face the difficult task of a potential shift toward policy normalization.
Some BOJ watchers expect the yield cap program, implemented under Ueda's predecessor in 2016, to be modified as soon as the next policy meeting in July.
"The side-effects (of the program) have been lessening somewhat. That being the case, we cannot deny the possibility that they will become more evident if inflation accelerates and overseas bond yields rise," Ueda told the press conference.
"We will weigh the pros of the yield curve control program against the cons and decide what needs to be done at that point," the governor said when asked if making the program more flexible is an option.
Driven largely by higher import costs that have increased due to the weak yen, Japan's inflation rate has stayed above 2 percent for a year.
Ueda said a growing number of companies have been going ahead with price hikes to pass on higher costs, a change from the past. Price hikes have been particularly broadening among food and daily necessities and spreading to some services.
Still, the BOJ maintained that the year-on-year increase in core CPI will likely "decelerate toward the middle of fiscal 2023 (starting in April)," the BOJ said in a statement.
To underline the importance of more robust wage growth for consumers to cope with inflation, the BOJ's policy guidance now states that the inflation target should be achieved "accompanied by wage increases."
The world's third-largest economy narrowly escaped a recession in 2022 and grew for a second consecutive quarter in January-March. But the prospect of slowing overseas demand is casting a cloud over Japan's sustained recovery from the fallout caused by the COVID-19 pandemic, aided by export growth.
