By Leika Kihara
TOKYO, Sept 8 (Reuters) - The last time Japan's central bank lifted its main policy rate half a percentage point, prices were so hot the land the Imperial Palace sat on was said to be worth more than the combined real estate of California.
That was 1989, the peak of Japan's asset bubble that popped soon after, creating the economy's "Lost Decade" - fast-forward 37 years and investors are asking: could the Bank of Japan lift rates 50 basis points next week?
While the consensus view points
to a conventional 25-bp hike to 1.25% at the September 17-18 meeting, with current price pressures nothing like the 1980s, the bigger concern for the bank is keeping markets convinced it is not behind the curve on inflation.
People familiar with the central bank's thinking say the bank has little appetite to deliver a bigger-than-usual 50-basis-point rate hike this month, with near-term price pressures contained and the risk of shocking a public used to decades of near-zero borrowing costs.
The BOJ would opt for the usual 25-point increase, if it were to hike, to avoid upending markets and allow itself time to scrutinise the impact higher rates could have on corporate and household activity, the sources said.
With the Middle East conflict, a tight domestic job market and rising import costs from a weak yen driving up inflation, however, the BOJ is considering speeding up the pace of rate hikes to roughly once a quarter, the sources said.
That is all more reason to forgo a big hike in September, a move that could backfire by perversely stoking fears the BOJ was already behind-the-curve in dealing with inflation, analysts say.
"Doing a 50-point hike could be seen as a sign of the BOJ's desperation and put the market's focus on the risk of it being behind the curve," said Nobuyasu Atago, a former BOJ official who is currently chief economist at Rakuten Securities Economic Research Institute.
"The BOJ will probably hike rates to 1.25% this month and do another 25-point increase in December or January next year, as a precaution against mounting inflation risks," he said.
"With the bond market already jittery, there's no point for the BOJ to stage a surprise and cause further turmoil."
KEEPING SOME POWDER DRY
The BOJ began its current tightening cycle in 2024 and has since then raised its policy rate by 25-bp increments at a pace of roughly twice a year.
In the past, BOJ officials stressed the need to move cautiously to avoid cooling sentiment in an economy that had been mired in deflation for nearly three decades.
In recent months, however, more acute price pressures arising from sharp yen declines have created a greater sense of urgency in Japan and beyond.
A slew of hawkish BOJ commentary and pressure from U.S. Treasury Secretary Scott Bessent have cemented views the BOJ will raise interest rates this month.
Comments by hawkish BOJ board member Hajime Takata sparked speculation of a bigger-than-usual increase.
However, BOJ Governor Kazuo Ueda said last week that economic and price conditions were moving roughly in line with projections, suggesting inflation risks have not heightened enough to justify a bigger-than-usual hike.
"We hope to continue raising interest rates as financial conditions remain accommodative," Ueda said. "On the other hand, we've raised rates five times so far, so we need to carefully assess the cumulative impact on the economy."
The yen's jump to a seven-month high around 153 per dollar, well off its 40-year low near 164 hit in July, has also taken some pressure off the BOJ to lift the currency with a big hike.
"Given the BOJ can probably deliver two more rate hike rates this year, there's no point going for 50 all at once," one of the sources said.
"Recent data shows inflation hasn't accelerated sharply in a way that warrants a bigger-than-usual rate hike," another source said, a view echoed by two more sources. The sources spoke on condition of anonymity as they were not authorised to speak publicly.
Recent data shows the economy hardly in need of the kind of aggressive monetary tightening aimed at cooling red-hot demand.
While a recent spike in producer prices is seen piling pressure on consumer inflation in coming months, there are scant signs of an alarming spiral of soaring prices and wages.
BOJ executives have stressed the need for vigilance about the impact of past rate hikes on bank lending, given uncertainty on how the public could react to higher rates after decades of ultra-loose monetary policy.
So far, financial conditions remain accommodative with bank lending rising 5.4% year-on-year in August.
Doves in the nine-member board, however, may see a stronger need to move cautiously as the BOJ's policy rate approaches levels deemed neutral to the economy, estimated by its staff as sitting somewhere between 1.1% and 2.5%.
Board member Toichiro Asada, the sole dissenter to the BOJ's decision in June to raise rates to 1%, told Reuters in July he wanted to see demand-driven inflation before supporting rate increases.
Ayano Sato, another dovish board member who joined on June 30, said the central bank must focus not just on upside price risks but both downside risks to growth.
"I won't be surprised if some board members see the need for a more cautious approach to rate hikes than markets, which are getting a bit ahead of themselves," said Mari Iwashita, executive rates strategist at Nomura Securities. "The BOJ is likely to stick to a 25-basis-point hike for the time being."
(Reporting by Leika Kihara; additional reporting by Takahiko Wada, Takaya Yamaguchi and Tamiyuki Kihara; Editing by Sam Holmes)
