By Leika Kihara
TOKYO, March 27 (Reuters) – The Bank of Japan on Friday released an updated estimate on the country’s natural rate of interest as part of its efforts to enhance communication as it ends an era of ultra-low rates.
The release came amid increased market attention to how close the central bank’s short-term policy rate has approached levels deemed neutral to the economy, which is key to the pace and timing of additional hikes.
In the updated estimate, Japan’s natural rate of interest, also known as the neutral rate that neither cools nor overheats the economy, stood in a range of around -0.9% to +0.5%, the central bank said.
The range, which consists of estimates using six models, was largely unchanged from a previous estimate showing Japan’s natural rate of interest at -1.0% to +0.5%.
The natural rate of interest is defined as the level of the real interest rate that is neutral to economic activity and prices.
Analysts have interpreted the BOJ’s estimate as meaning that if inflation were to hit its 2% target, the bank can raise its short-term rate at least to around 1% without cooling growth.
“Although the range itself has not changed significantly, a closer look reveals that many of the estimates have recently been moderately on the rise,” partly reflecting an increase in Japan’s potential growth rate, the BOJ said.
Given uncertainty surrounding the estimates of the natural rate, the BOJ would look at various data points to measure the degree of monetary accommodation, the paper said.
The BOJ keeps short-term rates at 0.75% even though inflation has hovered around 2% for nearly four years, meaning inflation-adjusted, real borrowing costs remain very low.
By pushing up borrowing costs to levels deemed neutral to the economy, the BOJ can remove what it sees as excessive monetary stimulus.
But estimating the neutral rate is not easy with different models yielding varying results. Major central banks use neutral rates as a benchmark but warn against overly relying on them in conducting monetary policy.
In pushing up interest rates toward levels deemed neutral to the economy, the BOJ will also assess how past rate hikes have affected Japan’s financial conditions, it said.
While funding costs are on the rise, overall funding demand remains firm due to the economy’s recovery and an increase in large-scale corporate acquisitions, the BOJ said.
“In light of these developments, it can be considered that Japan’s financial conditions remain accommodative even after the rate hike in December,” it added.
The release of the new natural rate estimate came after the BOJ’s disclosure on Thursday of a new indicator for measuring underlying inflation and updated data on Japan’s output gap.
The revised output gap data showed demand exceeded supply capacity for a 15th straight quarter to hit +0.45% in the third quarter of 2025, overturning its previous estimate that had indicated excess supply for about five and a half years.
The findings suggested intensifying labour shortages and solid domestic demand are propping up growth and inflation and could give the BOJ further justification to raise rates, analysts say.
The slew of disclosures followed a pledge by Governor Kazuo Ueda last week to enhance communication on key policy themes and came amid simmering market expectations for a near-term interest rate hike.
Japanese government bond yields rose on Friday, with five-year yields hitting a record high, as the Middle East conflict and recent central bank signals heightened inflation concerns and led investors to reprice the path of rate hikes.
(Reporting by Leika Kihara; Editing by Himani Sarkar, Muralikumar Anantharaman and Thomas Derpinghaus)
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