What could go wrong if Japan delays further rate hikes

news.az · Feb 26, 2026 · Collected from GDELT

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Former Bank of Japan Governor Haruhiko Kuroda has publicly urged the central bank to continue raising interest rates and has warned that expansive government spending could intensify inflationary pressures in Japan. His remarks are significant not only because of their content but also because of who is delivering them. Kuroda was the architect of Japan’s most aggressive monetary easing era. For years, he championed ultra low interest rates, massive asset purchases, and extraordinary stimulus measures designed to pull Japan out of deflation, News.Az reports. RECOMMENDED STORIES Births in Japan hit record low for 10th straight year Asian shares surge as Nvidia eases AI concerns SkyDrive flies first “flying car” over Tokyo Bay Microsoft Japan offices raided over Azure probe For such a figure to now advocate further rate increases and caution against fiscal expansion signals that Japan’s economic regime has shifted. The policy debate is no longer dominated by fears of deflation. Instead, it centers on how to manage a more complex environment marked by firmer inflation, rising wages, and changing global financial conditions. This transition is delicate. Japan’s financial system, corporate sector, and public finances were structured around extremely low borrowing costs. Even modest increases in rates alter incentives and expectations across the economy. Kuroda’s intervention therefore highlights a broader turning point in Japan’s macroeconomic trajectory. Why Kuroda’s voice carries weight Haruhiko Kuroda is closely associated with the era of aggressive monetary stimulus that defined Japanese policy for over a decade. Under his leadership, the Bank of Japan introduced unprecedented asset purchases, negative interest rates, and yield curve control. These policies aimed to break a deflationary mindset that had become entrenched in households and businesses. Because he once defended the necessity of extraordinary easing, his shift toward supporting gradual tightening carries credibility. He understands both the risks of acting too late and the dangers of acting too early. His view reflects deep institutional knowledge of how fragile Japan’s inflation process once was, and how difficult it was to escape stagnation. When a former central bank chief of his stature signals that the economy can now withstand higher rates, markets interpret that as confirmation that structural conditions have changed. It suggests that inflation and wage dynamics may be more durable than in previous cycles. The case for continued rate hikes Kuroda’s argument rests on the idea that Japan’s economy is in a stronger position than it has been in decades. Inflation has become more persistent. Wage growth is gaining momentum. Corporate profits have improved in several sectors. These developments support a gradual normalization of monetary policy. The term normalization is important. It does not imply aggressive tightening. Rather, it means moving away from crisis level stimulus toward a policy stance that neither overstimulates nor unnecessarily restrains the economy. In practical terms, that involves measured increases in interest rates, carefully calibrated to avoid choking off growth. Gradual rate hikes serve several purposes. They help anchor inflation expectations by signaling that the central bank remains committed to price stability. They reduce the risk of asset price distortions that can emerge when borrowing costs remain too low for too long. They also restore some policy space, giving the central bank room to cut rates in the future if conditions deteriorate. The warning on government spending Alongside his support for rate increases, Kuroda cautioned against expansive fiscal policy. His concern is that large government spending programs could amplify inflationary pressures at a time when the economy is already experiencing firmer prices. Fiscal policy affects aggregate demand directly. When the government increases spending significantly, it injects purchasing power into the economy. If supply constraints or strong wage growth are already pushing prices higher, additional demand can intensify inflation. There is also a market dimension. Increased government spending often implies higher borrowing needs. As the Bank of Japan steps back from large scale bond purchases, the private market must absorb a greater share of new debt issuance. If investors anticipate larger deficits without a credible long term stabilization plan, they may demand higher yields. Rising yields can tighten financial conditions abruptly, complicating the central bank’s efforts to normalize policy in an orderly fashion. Monetary and fiscal coordination Although central banks operate independently, their decisions do not occur in isolation. Fiscal policy shapes the environment in which monetary policy functions. When fiscal and monetary authorities move in opposite directions, policy effectiveness can be diluted or destabilized. If the government pursues aggressive spending while the central bank raises rates, the two policies may partially offset each other. However, the interaction can also create volatility. Markets may perceive policy incoherence, leading to swings in bond yields or currency valuations. Kuroda’s warning underscores the importance of coordination. Fiscal discipline does not necessarily mean austerity. It means calibrating spending to avoid overheating and maintaining credibility regarding long term debt sustainability. The role of wages Wage growth is central to Japan’s policy debate. In past cycles, inflation often proved temporary because it was not supported by sustained wage increases. Without rising incomes, households resisted higher prices and companies hesitated to raise wages further, causing inflation to fade. The current environment appears different. Labor shortages, demographic pressures, and stronger corporate earnings have contributed to more robust wage settlements. If wage growth becomes self sustaining, inflation can remain closer to target without relying on external shocks such as currency depreciation. This wage dynamic is what gives policymakers confidence to consider higher interest rates. It is also what makes fiscal expansion potentially more inflationary. If wages and demand are already strengthening, additional stimulus could push inflation beyond comfortable levels. The yen factor The exchange rate plays a meaningful role in Japan’s inflation outlook. A weaker yen increases the cost of imported goods, particularly energy and food. These higher import prices can feed through to consumer inflation. If fiscal expansion coincides with a weak currency, the combined effect could amplify price pressures. Conversely, continued rate hikes may support the yen by narrowing interest differentials with other economies. Currency stabilization can moderate imported inflation, easing some pressure on households. Kuroda’s warning implicitly acknowledges this interaction. Fiscal expansion in a weak currency environment can complicate inflation management, forcing the central bank to respond more assertively. Implications for households Japanese households are sensitive to both inflation and borrowing costs. Higher interest rates may raise mortgage payments for those with variable rate loans and increase borrowing costs for consumer credit. At the same time, higher rates can improve returns on savings and deposits, benefiting savers who endured years of near zero yields. The net impact depends on the balance between wage growth and price increases. If wages continue to rise in line with inflation, households may adjust without significant strain. If inflation outpaces income growth, living standards could come under pressure. A gradual and well communicated normalization path helps households plan and adjust expectations. Abrupt changes, by contrast, risk eroding confidence. Implications for businesses Companies face a mixed environment as rates rise. Borrowing costs increase, particularly for highly leveraged firms. Investment decisions may become more selective. On the other hand, stronger wage growth and healthier demand can support revenues. Banks and financial institutions may benefit from higher rates, as wider interest margins improve profitability. Insurers and pension funds may also gain from improved returns on fixed income assets. Export oriented firms must also consider currency movements. A stronger yen can reduce competitiveness abroad but lower import costs. A weaker yen supports exports but increases input costs. Monetary policy decisions influence these dynamics indirectly. Financial market considerations Japan’s government bond market is among the largest in the world. For years, the Bank of Japan played a dominant role through its bond purchases and yield management framework. As normalization proceeds, the private sector must absorb a greater share of issuance. This transition requires careful communication. Markets are sensitive to signals regarding the pace of rate hikes and the scale of bond purchases. Volatility in yields can spill over into equities and global markets. International investors also watch Japan closely because shifts in Japanese rates can influence global capital flows. Japanese institutional investors allocate significant funds abroad. If domestic yields rise, some capital may be repatriated, affecting global bond markets and exchange rates. Risks of moving too fast While Kuroda supports gradual hikes, the risk of overtightening remains. Japan still faces structural headwinds, including an aging population and uneven productivity growth. If rate increases outpace the economy’s ability to adjust, growth could slow sharply. Consumer spending remains sensitive to real income trends. If higher borrowing costs coincide with weak wage growth, domestic demand could falter. Global uncertainties, including trade tensions and geopolitical risks, also affect Japan’s export sector. For these reasons, the empha