Former central bank official issues interest rate warning: Bank of Japan's current interest rate peak may surpass 2%, and the pace of rate hikes could suddenly accelerate.

A former official of the Bank of Japan said that the Bank of Japan may accelerate its rate hikes later this year and eventually raise the benchmark interest rate to over 2% because the central bank is urgently trying to contain almost out-of-control inflation. Etsuro Honda, a former Honorary Professor of Economics at the University of Tokyo who left the Bank of Japan in 1999, said in an interview with the media on Wednesday: "I believe that the peak interest rate will be higher than what most people currently expect." "The terminal rate will be around 2%, or possibly slightly higher than 2%." Under the leadership of Bank of Japan Governor Haruhiko Kuroda, the Bank of Japan has raised the benchmark interest rate five times, with the most recent increase occurring last month, raising the benchmark interest rate to 1%, the highest level in 31 years. According to a survey report conducted among economists after the rate hike in June, most economists expect another rate hike before the end of the year, and the terminal interest rate for this round of rate hikes could be 1.75%. So far, there is no clear signal that the rate hikes are significantly hampering business activities. Bank loans in June grew at the fastest pace since the outbreak of the COVID-19 pandemic, and the latest Tankan survey by the Bank of Japan showed an improvement in the corporate financing environment for the first time in a year. Large companies reported an improvement in the business bill issuance environment. Honda said, "Policies should be thought of in a dynamic way rather than a static way." He added that the terminal interest rate is not just about the mathematical calculation of the neutral rate but also includes factors such as inflation overshooting before the Bank of Japan explicitly tightens policy. So far, authorities have taken a "reactive" approach to policies as they seek to achieve a virtuous cycle, where wage increases drive demand-driven price increases. With potential inflation nearing the 2% target, the Policy Board may shift to a more proactive stance to prevent excessive price growth. According to some local reports at the time, Honda was reportedly included in a shortlist of potential candidates for the Governor of the Bank of Japan together with Kuroda in 2023. As one of Japan's top inflation experts, Honda currently does not see overheating inflation as a serious threat, and the Bank of Japan still has time to assess wage momentum and wait for information later this year to judge the prospects for wage increases in 2027. However, if this momentum eventually proves to be as strong as it has been in recent years, based on Honda's calculations using the Taylor Rule, he believes that potential inflation could exceed 2% next year. This could force the Bank of Japan to shift its stance towards restrictive policy settings to combat inflation. So far, the Bank of Japan has been gradually raising interest rates while maintaining loose policy settings to generate some inflation, as Japan continues to recover from over a decade of deflation that severely impacted the economy around the turn of the century. A key challenge is that unlike in Europe or the United States, inflation expectations in Japan are not anchored around 2%, making it harder for the Bank of Japan to convince businesses and households that price growth will remain near its target, he said. Honda said, "If the Bank of Japan continues to passively deal with inflation for a year, it could be forced into a situation where it must quickly move forward with raising rates." "That would be very different from the moderate rate hike process Kuroda has done so far." Before Honda made his latest hawkish views public, Japanese wages rose again in May, easily outpacing inflation and reinforcing the Bank of Japan's hawkish policy stance to continue raising rates. A statistical report released by Japan's Ministry of Health, Labour, and Welfare on Tuesday showed that nominal wages in Japan rose by 3.2% in May compared to the same period last year, down from a revised increase of 3.6% in April. The data slightly below economists' average expectations, but marks the fourth consecutive month of wage growth of at least 3% domestically, setting a new record for the longest period of continuous growth of at least 3% since 1992. Before the release of Tuesday's statistical data, the final results of this year's wage negotiations in Japan were announced last week. Members of the largest union organization under the Japan Trade Union Confederation received wage increases of over 5% for the third consecutive year - the first time since 1989-1991 that such continuous growth data records have appeared. The continued strength of wages highlights that despite difficulties related to disruptions in the Japan supply chain due to Middle East geopolitical conflicts and a significant increase in inflation, employers are still committed to raising wages. This reinforces the view of the Bank of Japan that the benign "wage-price spiral" system is still intact and keeps it on a hawkish policy track of further rate hikes.