The Bank of Japan (BOJ) will evaluate the "pros and cons" of raising interest rates at its next policy meeting, Governor Kazuo Ueda said on Monday, giving the strongest signal yet of a potential hike later this month.
The yen and bond yields rose after the remarks, leading markets to price in a roughly 80% chance of a rate hike at the Dec. 18-19 meeting, compared with around 60% last week.
In a speech to business leaders in the city of Nagoya, Ueda voiced confidence that Japan's economy will rebound from a contraction in the third quarter, with the hit from U.S. tariffs proving smaller than initially feared.
With tariff impact worries receding, the likelihood of the BOJ's economic and price projections being met is rising, Ueda said, signalling conditions for a hike were falling into place.
"The BOJ is at the stage where it should examine whether firms' active wage-setting behavior will continue," which is key to how soon it will raise the policy rate, Ueda said.
Labor shortage is more acute, corporate profit remains high and the main business lobby has called on members to continue raising wages, he said.
The BOJ was "actively collecting" data on the wage outlook ahead of its December policy meeting, he added.
"We will examine and discuss economic and price developments at home and abroad, as well as market moves ... and consider the pros and cons of raising interest rates," Ueda said.
The yen rose 0.4% to a session high of 155.49 per dollar after Ueda's remarks. The yield on the two-year Japanese government bond – the most sensitive to the BOJ's policy rate – rose 2 basis points to 1.01%, its highest since June 2008.
"Ueda essentially pre-announced a December hike," said Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities. "With a December hike pretty much baked in, standing pat would cause huge market turbulence."
The BOJ exited a massive, decadelong stimulus program last year and raised its policy rate to 0.5% in January on the view that inflation was on the cusp of sustainably meeting its 2% target.
While the bank has kept the rate steady since, a growing number of board members either proposed a hike or called for doing so, as stubbornly high food prices keep consumer inflation beyond 2% for well over three years.
A Reuters poll last month showed a slim majority of economists expect a rate hike in December. All foresee a rise to 0.75% by March.
With real interest rates deeply negative, another hike would still leave borrowing costs low and be tantamount to "easing off the accelerator" rather than "applying the brakes," Ueda said.
"Being too late in adjusting the degree of monetary support could cause very high inflation and force us to respond rapidly, which would cause turmoil," Ueda told a news briefing after the speech.
Ueda offered no clues on how high the BOJ could eventually raise rates. He said the BOJ will provide more information on how far the rate is from levels deemed neutral to the economy, once it raises the policy rate to 0.75%.
The slow pace of hikes has been a factor behind a weakening yen, which has been a headache for government policymakers concerned about higher import costs stoking inflation.
Asked about the yen on Monday, Ueda said the weakness is likely to accelerate consumer inflation – a factor to which the BOJ must be vigilant in setting policy.
Renewed declines in the yen have raised the prospect of currency intervention, highlighting the administration's concern over the negative impact of the currency's fall.
Sources have told Reuters the BOJ is preparing markets for a possible rate hike as soon as December, as worries about sharp yen falls return and political pressure to keep rates low fades.
