Analysis-Trade deal clears way for BOJ to tiptoe back to rate hikes

By Leika Kihara

TOKYO (Reuters) -U.S. President Donald Trump’s trade deal with Tokyo opens scope for the Bank of Japan to raise interest rates again this year, sources say, a prospect the central bank may start to telegraph by offering a less gloomy view on the economic outlook.

But a near-term rate hike is hardly a done deal with the timing dependent on whether the economy can withstand the impact of U.S. tariffs, said four sources familiar with the BOJ’s thinking.

“As clouds hanging over U.S. trade policy clear, the BOJ may see scope to raise rates this year,” one source said, a view echoed by two other sources.

“It’s not as if all of the trade-related uncertainty has cleared,” a second source said, adding the BOJ must scrutinise data through autumn for clues on how U.S. tariffs affected the economy, a second source said.

The world’s fourth-largest economy has been hobbled by tepid consumption, rising living costs and a weakened manufacturing sector.

A lack of clarity over the outcome of Japan’s trade talks with the U.S. has been among factors the BOJ cited in slashing its growth forecasts in May and calling a pause in rate hikes.

This week’s announcement of Japan’s trade deal with the U.S., however, has reduced uncertainty and removed a key hurdle for resuming rate hikes, the sources said.

The BOJ may begin dropping hints of a re-start of rate hikes by offering a less gloomy view on the outlook compared with the current one focused on tariff-induced risks, they said.

In the first sign of such optimism, BOJ Deputy Governor Shinichi Uchida said on Wednesday the deal heightened the chance of Japan durably hitting the bank’s 2% inflation target – a prerequisite for further rate hikes.

“The BOJ needs to adjust monetary policy to best balance upside and downside risks,” said Uchida, who also highlighted inflationary pressure from rising food costs.

Uchida’s upbeat comments contrasted with those by Governor Kazuo Ueda in May that uncertainty regarding the BOJ’s baseline scenario was “higher than in the past” because of tariff-related risks.

In a quarterly report due at its next policy meeting on July 30-31, the BOJ may offer a more sanguine view than before on the impact of U.S. tariffs, the sources said.

The board may also revise up this year’s inflation forecast and consider tweaking its current view that risks to the price outlook are skewed to the downside, they said.

“The trade deal opens the way for the BOJ to raise rates,” said JP Morgan Securities economist Ayako Fujita. “It adds reasons for the BOJ to revise up its forecasts,” said Fujita, who expects a rate hike in October.