Japanese Prime Minister's advisor pours cold water: "Fiscal first, monetary later"; no interest rate hike before March next year.

An important economic adviser to Japanese Prime Minister Sanae Takaichi has issued a warning that the Bank of Japan is unlikely to raise its benchmark interest rate before next March, and that the policy focus should first be on boosting domestic demand through large-scale fiscal spending, with monetary policy normalization coming afterwards. This statement has poured cold water on the market's previously aggressive expectations for a near-term rate hike.

As a member of Sanae Takaichi’s Economic Growth Strategy panel, Goushi Kataoka stated clearly in a Tuesday interview with Bloomberg, “Fiscal policy is the starting point.” He believes authorities must first confirm that additional large-scale spending can effectively stimulate domestic demand, and estimates that a supplementary budget of about 20 trillion yen (around $129 billion USD) will be needed this fiscal year—a scale far exceeding the 13.9 trillion yen compiled by Takaichi’s predecessor last year.

Kataoka’s remarks indicate that the government’s advisory team tends to delay the rate hike schedule, which stands in sharp contrast to predictions made by most economists that the Bank of Japan will raise rates no later than January. Although Bank of Japan Governor Kazuo Ueda reiterated his willingness to gradually adjust the degree of monetary easing in a Tuesday meeting, Kataoka pointed out that, given the current weak economic data, “a rate hike in January is unlikely” from a logical perspective.

With details of the economic stimulus plan set to be released this week, investors are closely watching how the Japanese government and central bank will balance fiscal expansion and monetary normalization, as well as the potential impact of a delayed policy timetable on the yen’s exchange rate and financial markets.

“Fiscal First, Monetary Second” Policy Path

Kataoka elaborated on the policy sequence as seen by the government advisory team. He said that, if the economic plan to be announced later this week can be effectively implemented, domestic demand could begin to expand as early as the first quarter of next year.

On this basis, Kataoka stated: “Depending on the situation, the earliest conditions for a rate hike may be in March.” As a former member of the Bank of Japan’s Policy Board, Kataoka has been a firm supporter of fiscal and monetary stimulus during his tenure. His view suggests that monetary policy should remain on hold until the effects of fiscal stimulus are verified by data.

This also means that, despite the recent drop of the yen below the key psychological threshold of 155 against the dollar raising market concerns, for Takaichi’s advisory team, the priority of fiscal stimulus remains higher than the urgency of defending the exchange rate or curbing inflation through rate hikes. Kataoka’s comments show that although the overall path toward policy normalization via rate hikes remains unchanged, there are obvious risks of delay in timing.

Weak Economic Fundamentals Restrict Rate-Hike Room

The core argument supporting the delay in rate hikes is the current state of Japan’s economic fundamentals. Kataoka pointed out that Japan’s economy “is not necessarily in a favorable position.” Data shows that Japan’s real GDP shrank in the three months to September, marking the first contraction in six quarters.

Also, the core CPI indicator excluding food and energy remains below 2%. Based on this data, Kataoka believes that acting prematurely before domestic demand is solid does not make sense. His view aligns with that of former Bank of Japan Deputy Governor Masazumi Wakatabe, who also stated after attending Takaichi’s economic panel meeting last week that Japan’s economic conditions are not good—also hinting at opposition to an early rate hike.

By contrast, a Bloomberg survey last month showed that the vast majority of observers predict the Bank of Japan will raise rates before January next year. The advisory team’s cautious stance highlights the significant gap between policymakers and market expectations.

Communication and Game Between the Central Bank and Government

On the same day Kataoka made these remarks, Sanae Takaichi and Kazuo Ueda held their first bilateral meeting since her appointment. According to media reports after the meeting, Kazuo Ueda explained to the Prime Minister that the central bank is gradually adjusting monetary easing based on economic improvement, and that a mechanism of combined price and wage increases is being restored. Ueda stated that Takaichi “understood” this position.

This statement was interpreted by the market as a hawkish signal that the central bank is persisting with policy normalization. Ueda also stressed that the bank will make appropriate policy decisions based on data and will closely cooperate with the government in monitoring exchange rate moves and their impact on the economy.

Although Sanae Takaichi previously called a rate hike “foolish” when serving as a lawmaker in September 2024, Kataoka predicts that as Prime Minister, she won’t exert any public pressure on the central bank. He said: “I don’t think she will say that rates shouldn’t be raised.” This suggests that although the government advisers favor delaying rate hikes, they may respect the central bank’s independence, with both parties seeking a delicate balance in the process. The Bank of Japan’s next rate-setting meeting is scheduled for December 19th.

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