By Leika Kihara
TOKYO (Reuters) -U.S. President Donald Trump’s trade deal with Tokyo opens scope for the Bank of Japan to raise interest rates again this year, sources say, a prospect the central bank may start to telegraph by offering a less gloomy view on the economic outlook.
But a near-term rate hike is hardly a done deal with the timing dependent on whether the economy can withstand the impact of U.S. tariffs, said four sources familiar with the BOJ’s thinking.
“As clouds hanging over U.S. trade policy clear, the BOJ may see scope to raise rates this year,” one source said, a view echoed by two other sources.
“It’s not as if all of the trade-related uncertainty has cleared,” a second source said, adding the BOJ must scrutinise data through autumn for clues on how U.S. tariffs affected the economy, a second source said.
The world’s fourth-largest economy has been hobbled by tepid consumption, rising living costs and a weakened manufacturing sector.
A lack of clarity over the outcome of Japan’s trade talks with the U.S. has been among factors the BOJ cited in slashing its growth forecasts in May and calling a pause in rate hikes.
This week’s announcement of Japan’s trade deal with the U.S., however, has reduced uncertainty and removed a key hurdle for resuming rate hikes, the sources said.
The BOJ may begin dropping hints of a re-start of rate hikes by offering a less gloomy view on the outlook compared with the current one focused on tariff-induced risks, they said.
In the first sign of such optimism, BOJ Deputy Governor Shinichi Uchida said on Wednesday the deal heightened the chance of Japan durably hitting the bank’s 2% inflation target – a prerequisite for further rate hikes.
“The BOJ needs to adjust monetary policy to best balance upside and downside risks,” said Uchida, who also highlighted inflationary pressure from rising food costs.
Uchida’s upbeat comments contrasted with those by Governor Kazuo Ueda in May that uncertainty regarding the BOJ’s baseline scenario was “higher than in the past” because of tariff-related risks.
In a quarterly report due at its next policy meeting on July 30-31, the BOJ may offer a more sanguine view than before on the impact of U.S. tariffs, the sources said.
The board may also revise up this year’s inflation forecast and consider tweaking its current view that risks to the price outlook are skewed to the downside, they said.
“The trade deal opens the way for the BOJ to raise rates,” said JP Morgan Securities economist Ayako Fujita. “It adds reasons for the BOJ to revise up its forecasts,” said Fujita, who expects a rate hike in October.
While the BOJ is set to keep rates steady next week, markets are pricing in the chance of a near-term hike. Two-year government bond yields, which are most sensitive to rate expectations, hit a nearly four-month high of 0.845% on Thursday.
CLOUDS STILL LOOM
The BOJ exited a decade-long, massive stimulus last year and raised its short-term policy rate to 0.5% in January on the view Japan was progressing towards durably achieving its price goal.
While core inflation has remained above its 2% target for well over three years, the central bank has moved cautiously in hiking rates on concern over hurting a fragile economy.
There is no consensus within the board on how soon to hike rates. With real interest rates deeply negative, hawks like Naoki Tamura have warned of the risk of going too slow.
But pessimists in the BOJ are not convinced the economy is out of the woods given lingering risks, the sources said.
Japan’s economy shrank in the first quarter as rising living costs weighed on consumption, stoking fears of recession.
The U.S. has yet to clinch trade deals with Japan’s big export destinations like China. While exports and output have held up, analysts expect the hit from tariffs to show up more clearly in coming months’ data.
Even taking into account the trade deal, U.S. tariffs will shave 0.55 percentage point off annual GDP growth, according to estimates by former BOJ board member Takahide Kiuchi.
“The economy isn’t on a strong footing with consumption flat and the export outlook still gloomy,” said a third source.
While praising the trade deal as reducing uncertainty, deputy governor Uchida warned it was still not clear how U.S. tariffs could affect the business mood and spending plans.
The key would be the BOJ’s next “tankan” business survey due in October and a quarterly meeting of its regional branch managers that month, where the bank looks more closely into how firms across the country are weathering the hit from tariffs.
The findings will be available by the time the BOJ holds its policy meeting on October 29-30. For now, the market’s focus will turn to comments by Ueda, who will brief media after the two-day rate review concluding on July 31.
“The outlook report and the governor’s news conference will likely signal that the BOJ is moving closer towards raising rates again, albeit cautiously,” said Ryutaro Kono, chief Japan economist at BNP Paribas.
(Reporting by Leika KiharaEditing by Shri Navaratnam)
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