The International Monetary Fund on Friday urged the Bank of Japan to end its yield cap program and other unprecedented monetary easing steps while gradually raising interest rates as a result of the country's improving inflation outlook.
In normalizing monetary policy, the BOJ should take a "gradual and well-communicated" approach to anchor market expectations of the shift after a decade of powerful monetary easing that was designed to attain its goal of stable inflation at 2 percent, the IMF said.
BOJ Deputy Governor Shinichi Uchida on Thursday reassured financial markets that monetary conditions will remain "accommodative," ruling out rapid interest rate hikes even if the central bank decides to end its negative rate policy.
The BOJ sets short-term interest rates at minus 0.1 percent and currently allows 10-year Japanese government bond yields to rise above 1.0 percent.
The IMF has been urging the BOJ to make the yield cap program more flexible. The Japanese central bank, for its part, has gradually loosened its grip on 10-year yields, partly to address the side effects of keeping borrowing costs extremely low.
As BOJ board members appear to have grown more confident about wage growth and stable inflation, financial markets expect the negative rate to end as early as this spring and Uchida's comments lifted Japanese stocks and weakened the yen.
After concluding annual consultations with Japanese officials, the IMF said Japan's inflation rate, which has also been driven by higher import costs, is "becoming demand-driven," projecting that a closing output gap and nominal wage growth will mean the core inflation rate will remain above 2 percent until the second half of 2025.
"The framework (of yield control program and quantitative and qualitative easing) has already successfully met its intended objective of lowering interest rates below the neutral rate and raising inflation expectations," IMF staff said in a statement.
"If staff's baseline inflation forecast bears out, the BOJ should gradually raise the policy rate over its policy horizon (of three years) thereafter," it added.
The BOJ's monetary easing over the past decade has also allowed Japan to rein in debt-servicing costs despite the nation being among the advanced economies with the worst debt-to-gross domestic product ratios.
The IMF underscored the need for Japan to tighten fiscal policy and use more "realistic" assumptions for its rehabilitation outlook.
The COVID-19 pandemic and accelerating inflation have increased fiscal spending at a time of flagging public support for Prime Minister Fumio Kishida. The government drew up an economic package of over 17 trillion yen ($114 billion) last year to help struggling households hit by the cost of living crisis, through tax cuts and other means.
"Given a closed output gap and high debt-to-GDP ratio, the large, not-well-targeted fiscal stimulus in the November package was not warranted," the IMF said, adding that the income tax cut would have only a "limited" impact on growth.
