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Japan is used GBJBJBJGDPBJYour browser does not support the element.to the position in which it currently finds itself: apart from . Elsewhere, as inflation exceeded central-bank targets, rate-setters tightened monetary policy in rough proportion to the size of their overshoot. If the Bank of Japan had behaved in a similar manner to its 10 peers, notes Tim Baker of Deutsche Bank, the country’s interest rates would have increased by two percentage points over the past few years. Instead, they barely crept up, rising from -0.1% to 0.25%, despite nearly three years of price growth above the o’s target of 2%.That is because Japanese policymakers would like to kill off the country’s disinflationary decades once and for all. They received a gift when the current wave of inflation arrived from overseas. In 2021 and 2022, as import prices surged and the yen plunged, Japan received a whopping cost shock. Companies had little choice but to pass on higher costs, in the process breaking a taboo against price rises. Workers, in turn, received a strong incentive to seek higher wages. The o’s policymakers were pleased: they hoped to turn a bout of external “cost-push” inflation into internal “demand-pull” inflation, by way of a virtuous feedback loop between wages and prices.Now the central bank is beginning to change tack. On January 24th policymakers raised interest rates for the third time this cycle. Their growing confidence mostly stems from the national pay picture. Since last spring, nominal base wages for full-time workers have risen at a rate of nearly 3% year on year. So have services-producer prices, a leading indicator for broader services inflation, which is sensitive to wage growth.Analysts expect a second year of pay rises near 5% following , annual wage negotiations between firms and unions that will conclude in March. Moreover, inflation expectations are reaching a “screaming point”, says David Bowers of Absolute Strategy Research, a consultancy. Surveys of businesses’ and consumers’ medium-term inflation expectations are at, or approaching, record highs. “It has now become possible to envision achieving the price-stability target in a sustainable and stable manner,” said Himino Ryozo, the o’s deputy governor, on January 14th.Investors are buying into the turnaround, too. Short- and long-term Japanese yields have rallied (see chart). On January 15th the ten-year yield reached its highest level since 2011. The two- and 30-year yields have recently set similar records. Although this increase has coincided with surging yields in America, Germany and Britain, Japan’s bond market has been driven by very different underlying conditions. Investors are not spooked. Rather, inflation has provided them with optimism that Japan’s economy can regain its vim. And rather than being driven by a worsening fiscal trajectory, inflation has led to a bump in tax receipts. A slimmer budget deficit has nudged down government debt as a share of . Higher yields could in time raise public interest payments, but this will take a while. More than half of Japan’s government bonds are five or more years away from refinancing.Despite the increasingly hopeful state of affairs, Japan’s central bankers face a difficult balancing act. bristle at the high food and energy costs wrought by a weak yen, which is near a four-decade low. Interest-rate rises that are too cautious would prolong the pain unnecessarily. On the other hand, too ambitious a rate-rising cycle could strengthen the yen before inflation has taken root domestically, which might undermine the rise in inflation expectations that the o has worked so hard to achieve. With Japan’s economy showing signs of slack, China exporting enormous quantities of cheap goods and Donald Trump preparing tariffs, disinflationary hazards are appearing everywhere. The bank’s policymakers are likely to stick with a gradual approach, nudging up rates at a pace slow enough to disrupt nothing. Discomfort for Japanese shoppers today is a price worth paying for the chance of a much healthier economy in the years, and maybe even decades, to come.
