Bank of Japan chief Kazuo Ueda said Friday the central bank will "very likely" raise interest rates if underlying inflation continues to increase, stressing future decisions will be data dependent.

After its first interest rate hike in 17 years at its previous policy meeting in March, Ueda acknowledged Japan's experience with zero interest rates over a long period means determining how high rates should go is a "challenge."

For now, however, the governor underscored the need to maintain accommodative financial conditions as underlying inflation is still "somewhat below" the BOJ's target of 2 percent, adding the central bank is watching wage growth and service price inflation to ensure stable inflation.

"If underlying inflation continues to go up, we will be very likely raising interest rates," Ueda said, describing such a situation as "healthy."

"We have bought more flexibility in terms of what we will be doing with our policy. So depending on incoming data...we may change the short-term policy rate," the governor told an event hosted by the Peterson Institute for International Economics in Washington.

Bank of Japan chief Kazuo Ueda delivers a speech in Washington on April 19, 2024. (Kyodo)

The BOJ currently keeps short-term interest rates within a range between zero and 0.1 percent, as decided in March when it departed from unorthodox monetary easing.

It also ended its program to keep borrowing costs extremely low by controlling Japanese government bond yields, though it has vowed to continue buying long-term bonds to prevent a sudden spike in yields that will hurt the economy.

Ueda said long-term interest rates should be determined by market forces, adding the BOJ will "take time to consider and determine at what timing and what speed we will be reducing the amount of JGB (Japanese government bond) purchases."

The BOJ is scheduled to hold a two-day policy-setting meeting from Thursday, with financial markets expecting no change.

But the central bank is expected to raise its inflation forecasts for the current fiscal year ending March and the following year, anticipating around 2 percent inflation in fiscal 2026, the final year covered in its upcoming outlook report.

The governor said earlier this week that the BOJ would make a policy change if the impact of a weaker yen on inflation becomes pronounced, with the currency's sharp depreciation increasing import costs for resource-scarce Japan in recent years.

Ueda said the BOJ needs to have a "rough idea" of how the economy and inflation would respond when determining how much interest rates should be raised.

"We don't have a period of rising interest rates over a sustained period of time, as far as the last three decades go. So it's very hard to estimate this elasticity using past data," he said.

Ueda, an academic who as a BOJ board member played an instrumental role in introducing what is now known as "forward guidance," added, "I think this is going to be a challenge for us."

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