The recent period of high inflation in Japan has kick-started a virtuous cycle between wages and prices. If inflation expectations remain elevated and structural forces push up the neutral rate of interest over the coming years, monetary policy will become increasingly looser if the Bank of Japan keeps its policy rate around 0%. The upshot is that price pressures will continue to strengthen, forcing the Bank to lift interest rates in earnest. We now expect both inflation and the Bank’s policy rate to settle at 2% by 2030.
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