IMF urges BOJ to keep ultra-low rates, but be ready to shift course

TOKYO  – The Bank of Japan must keep monetary policy ultra-loose as it will take time to re-anchor inflation expectations to its 2-percent target, International Monetary Fund’s chief economist Pierre-Olivier Gourinchas told Reuters.

But the central bank must be vigilant to the risk of price growth overshooting expectations, and be ready to tighten policy if inflation stays above its target for too long, he said.

“There’s an opportunity right now” to re-anchor inflation expectations at the central bank’s target with underlying inflation exceeding 2 percent and wages starting to rise, Gourinchas said in an interview conducted on Tuesday.

“But it will take time. It won’t happen overnight” as the public must be convinced Japan won’t fall back to deflation, Gourinchas said, adding it was “too early” for the BOJ to tighten policy.

While it was appropriate to keep interest rates ultra-low, the BOJ must keep in mind the experience of other central banks that are still struggling to tame high inflation.

“Obviously, the history of the last two years is one where inflation that was supposed to be transitory, turned out to be not transitory,” Gourinchas said on the experience of the U.S. and European central banks.

“We could have similar dynamics in Japan. So, there is a need to be vigilant and to be ready to tighten monetary policy if inflation remains too elevated.”

Japan’s core consumer inflation hit 3.4 percent in April, staying above the BOJ’s target for a year, keeping alive speculation the BOJ could phase out its massive stimulus that critics say is distorting markets.

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Japan’s consumer inflation stays above central bank target as price hikes broaden

Viewing recent inflation as driven mostly by cost-push factors, BOJ Governor Kazuo Ueda has ruled out an early end to yield curve control (YCC) – a policy that sets a -0.1 percent target on short-term rates and a 0.5 percent cap on the 10-year bond yield.

Given the chance of inflation remaining elevated, the BOJ should communicate to markets its readiness to address inflation risks if they arise, Gourinchas said.

He also said it would be “very difficult” to tighten monetary policy while maintaining YCC, due to the challenge of determining the appropriate level for two rate targets.

“It’s probably safer to first move away from the control of long-term yields. And then, if the need arises to tighten monetary policy, it can do so as part of the usual tightening of the policy rate,” he said. “But that transition will be technically complicated.”

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