Bank of Japan Deputy Governor: AI demand shock affects neutral interest rate, but impact remains uncertain.

Bank of Japan Deputy Governor Shinichi Uchida said artificial intelligence (AI) is driving a surge in demand that is intensifying inflationary pressure and pushing up long-term interest rates, and its impact could extend further to the neutral interest rate. "First, this is a huge positive demand shock that is already exerting upward pressure on the economy and prices. Second, it may affect the supply side, for example by raising productivity and promoting capital stock accumulation, which in turn could affect r-star," Uchida said Monday in a speech. R-star refers to the level of interest rate that neither stimulates nor restrains the economy before accounting for inflation. The neutral interest rate is essentially r-star plus the inflation rate. Uchida's remarks suggest that as AI becomes more widespread, the neutral rates of central banks around the world may initially be forced higher, although the longer-term impact remains uncertain. Uchida noted that while growing AI demand has pushed up related stock prices and loosened financial conditions, large-scale bond issuance by technology companies has pushed up long-term yields, thereby tightening financial conditions. Similarly, over the longer term, the structural impact of AI could push monetary policy in different directions. "AI may quickly render certain forms of human capital obsolete, especially those skills designed for mental labor. It may also affect social inequality, because those with more technical skills and stronger adaptability may reap far greater gains than others," Uchida said, adding that these conflicting effects require careful study, and the overall impact of AI on r-star is still difficult to assess. "We do not yet have a clear answer," he said. Uchida's remarks came as economists and market participants try to assess how quickly and to what extent the Bank of Japan will raise interest rates further. The BOJ raised its policy rate to 1.25% at its September meeting, and the market widely expects it to raise rates again before the end of the year. The summary of opinions from the BOJ's September meeting showed that some policymakers believed it was necessary to accelerate the pace of rate hikes, or to bring rates close to the central bank's "target" as soon as possible, raising the possibility of further increases. Most opinions held that, amid rising inflationary pressure, it was necessary to continue raising borrowing costs after the September hike. One member was quoted as saying: "If signs of an upward deviation in prices are observed, the central bank will need to accelerate the pace of rate hikes." Another opinion said: "It is desirable for the central bank to raise the policy rate relatively quickly to roughly the target level," so as to leave room to respond to unexpected economic developments. These opinions highlight the committee's growing attention to inflation risks and reinforce the market's mainstream expectation of another rate hike this year. One member said: "Given the latest developments, we must consider the prospect that oil prices may remain high," suggesting vigilance over the ongoing impact of the Middle East conflict. However, not everyone believes the conditions for a rate hike are ripe. Two dovish members of the nine-member committee, Toichiro Asada and Ayano Sato, dissented from the September rate hike decision. The summary includes some opinions that may have come from them, warning that weak consumption and sluggish growth in services inflation are reasons to keep policy unchanged. The summary also showed that a Cabinet Office representative at the meeting urged the BOJ to "carefully examine the cumulative effects of past rate hikes," indicating concerns that higher interest rates could hit the economy. Meanwhile, some recently released macroeconomic data or surveys also support market expectations for a BOJ rate hike. The BOJ's quarterly Tankan survey released earlier this month showed that the business sentiment index for large manufacturers rose to 24 in September from 22, improving for a sixth consecutive quarter and reaching the highest level in more than eight years. The survey is one of the BOJ's most closely watched data releases. The latest Tankan report showed that the resilience of Japanese companies is continuing. Strong global AI demand has cushioned the impact of the Middle East conflict, keeping Japan's manufacturing PMI in expansion every month this year; rising real wages have supported services demand in the non-manufacturing sector. Against this backdrop, the latest survey may strengthen market expectations that the BOJ will raise rates again before December. In addition, Tokyo's key inflation gauge rose sharply as the impact of some temporary government measures faded. Data released by the Ministry of Internal Affairs and Communications last Friday showed that Tokyo's consumer price index excluding fresh food rose 2.7% year-on-year in September. That reading was above the median economist forecast of 2.3% and above last month's 1.8% gain. This was the first time the gauge had reached 2% or above since January. This supports the BOJ's stance of continuing to raise rates after authorities accelerated the pace of policy normalization.