Is the rate hike window in April? Former Bank of Japan Chief Economist warns: Failure to raise interest rates could lead to a "catastrophic sell-off" of the yen

Zhitong Finance APP learned that the former chief economist of the Bank of Japan said that the Iran war is increasing the upside risk of inflation, which strongly supports the possibility of the Bank of Japan raising interest rates as early as this month.

In an interview on Wednesday, former chief economist Sekine Toshiaki (Toshitaka Sekine) said, “If the aim is to assess the situation, I think taking action in April is feasible,” and “By the end of April, we will at least know whether the negative impact on the Middle East situation is just temporary.”

Although experts are still debating whether geopolitical shocks will cause inflation or deflation for Japan, a resource-poor country, Sekine Toshiaki’s comments suggest that when the Bank of Japan sets policy on 4月 28 日, it is likely to hold firmer confidence in the necessity of raising rates.

Sekine Toshiaki worked at Japan’s central bank for more than 30 years before leaving in 2020. He speculated that Bank of Japan officials may share the same view as him, because the brief minutes from the March policy meeting clearly show that the committee members’ concerns about inflation risks are intensifying.

Sekine Toshiaki said that after facing pressure for four straight years of price growth exceeding the Bank of Japan’s 2% target, the supply shock triggered by the Iran conflict will further push inflation higher. The Cabinet Office had estimated that for every 10% increase in oil prices, the inflation rate would rise by as much as 0.3 percentage points. Since the outbreak of the war, oil prices have risen by about 50%.

“Unlike when I worked at the Bank of Japan, since 2022, we have actually already experienced inflation overshoot,” Sekine Toshiaki said. “Given this, if another supply shock could lead to the risk of prices facing an overshoot again, I would tend to raise interest rates.”

Traders think the likelihood of a rate hike at this month’s committee gathering is about 70%. Even so, many observers of the Bank of Japan have noted that the final decision will depend on how the Middle East situation evolves, because Governor Ueda Kazuo has previously pledged to monitor both upside and downside risks to inflation.

“My view is that the upside risks are greater,” Sekine Toshiaki said. He added that Prime Minister Sanae Takachiho has been stepping up spending to rein in the cost of living, and it is very likely that further measures will be introduced. He said this could, in turn, generate inflationary pressure from the fiscal side.

Sanae Takachiho has signaled a preference for a gradual approach to rate hikes. Now it is crucial to watch whether the prime minister will try to prevent borrowing costs from rising when the economic outlook is unclear.

However, Sekine Toshiaki pointed out that if the Bank of Japan is unable to fulfill its mandate to stabilize inflation due to political factors, the price could be huge, because financial markets may respond forcefully.

“If that happens, the scenario that could arise is that foreign investors massively sell the yen, leading to further yen depreciation,” Sekine Toshiaki said. “Combined with higher oil prices, this would push upside inflation pressure to an unsettling level.”

Sekine Toshiaki currently serves as an economics professor at Hitotsubashi University. He believes that even if faced with market skepticism, Governor Ueda Kazuo, who came from academia, has already successfully scaled back the previously large-scale monetary easing policies, and he will take the actions he considers necessary.

“For Governor Ueda, this is a testing moment, even though he may not welcome such a test,” Sekine Toshiaki said. “History shows that if a central bank fails to take action in time, it can lead to serious consequences—Governor Ueda is as clear about that as anyone.”