The Bank of Japan will debate ending its negative interest rate policy at its two-day policy meeting from Monday as accelerating wage growth is increasing the chance of attaining stable inflation without hurting the economy.
If the Policy Board decides to remove the negative rate and goes ahead with what will effectively be the central bank's first hike in 17 years, it will mark a major shift away from the unprecedented monetary easing that Japan has seen over the past decade to put an end to deflation.
Financial markets expect the BOJ to end its negative rate policy either in March or April after it examines the outcome of the annual spring wage negotiations between labor unions and management. Sources familiar with the matter told Kyodo News that a decision to end the negative rate will likely come at the meeting ending on Tuesday.
The higher-than-expected average pay increase of 5.28 percent offered by major Japanese companies has boosted policymakers' confidence that a virtuous cycle of wage growth and price hikes is starting, a crucial factor for Japan to achieve the BOJ's 2 percent inflation target.
The preliminary results, announced by the Japanese Trade Union Confederation, the umbrella group of trade unions in Japan known as Rengo, marked the fastest pace of wage growth in 33 years.
The BOJ began imposing a minus 0.1 percent interest rate on some funds that commercial banks park at the central bank in 2016, in the hope of boosting their lending to companies and investment. The unorthodox policy was designed to dent the appeal of keeping funds at the BOJ.
To depress borrowing costs and stimulate the economy, the BOJ has also capped the benchmark yield on 10-year Japanese government bonds. Under what is known as yield curve control, 10-year yields have been guided to around zero percent.
In recent months, however, the central bank has loosened its grip and allowed the yields to rise above 1.0 percent, as their overseas counterparts trended higher in line with aggressive monetary tightening by the U.S. Federal Reserve, the European Central Bank and others to curb inflation.
When the negative rate is scrapped, the BOJ is expected to guide the overnight call rate to a range from zero percent to 0.1 percent. The rate used by interbank lending and borrowing is currently within a range between minus 0.1 percent and zero percent.
The nine-member board would also do away with the yield cap program, though the BOJ is expected to continue with its bond buying to prevent long-term interest rates spiking to the detriment of businesses and households. Its purchases of exchange-traded funds would also end, according to the sources.
Attention is also focused on what the BOJ, having long been a dovish outlier, will say about its policy outlook. Governor Kazuo Ueda has said monetary conditions will remain accommodative.
Headline inflation has stayed above the BOJ's target for nearly two years but it has not budged on its stance of keeping ultralow rates. This is based on the central bank's view that the recent bout of inflation is driven largely by the higher cost of imported energy and raw materials, compounded by a weak yen.
The BOJ's current policy is to retain its monetary easing framework and continue expanding its monetary base until core consumer inflation is stably above 2 percent. It has pledged "not to hesitate" to take more easing steps if needed.
Any change in tone will likely have a strong bearing on currency markets, analysts say, as the yen's weakness, particularly relative to the U.S. dollar, reflects the diverging monetary policy paths of Japan and the United States. The Fed is scheduled to hold a two-day meeting from Tuesday, with financial markets expecting it to start cutting interest rates later this year.
While market expectations of a policy change have grown in the run-up to the latest policy meeting, some analysts believe the next meeting in April, when the BOJ will update its forecasts for economic growth and inflation, will be more suitable for ending its negative rate.
Based on the central bank's current projections, core consumer prices, excluding volatile fresh food items, will rise 2.4 percent in fiscal 2024 beginning next month compared with a year earlier. The key gauge of inflation is projected to increase 1.8 percent in fiscal 2025.
"Whether service prices will rise and inflation expectations will further heighten will be key," said Masamichi Adachi, chief economist for Japan at UBS Securities.
"The BOJ will have to wait and examine (data) this summer even if it wants to go ahead with another rate hike" after lifting negative rates, he added.
Related coverage:
Japan firms offer 5.28% wage hike, biggest in over 30 years: survey
Japan averts recession in October-December period with 0.4% economic growth
