International Monetary Fund Japan mission chief Rahul Anand said in an interview on Friday that under the baseline scenario, the IMF expects the Bank of Japan to raise rates one more time, bringing the policy rate to a neutral level.
Anand stressed that with global uncertainty still elevated, monetary policy must be data-dependent and flexible.
His remarks came as the Bank of Japan gradually moves toward the neutral rate. The IMF estimates Japan's neutral rate range at 1.1% to 2.2%, with a midpoint of about 1.5%. The Bank of Japan's current policy rate of 1.25% already falls within that range.
Bank of Japan officials are closely monitoring core inflation as they consider further policy tightening. Governor Kazuo Ueda has said the inflation trend is approaching the central bank's 2% target, while emphasizing the need to ensure inflation settles sustainably at that level. The Bank of Japan expects core inflation to reach a level consistent with its target within the next 18 months.
Anand believes inflation pressures will persist as energy prices remain high and companies pass on costs more frequently. He expects Japanese inflation to briefly exceed 2% before easing back to around that level by the end of next year.
Current market pricing shows less than a 5% probability of a rate hike at the Bank of Japan's policy meeting in two weeks, but an 82% probability of a hike by year-end. People familiar with the matter said central bank officials prefer to avoid a rare back-to-back rate increase, but have not ruled out the possibility of another hike as early as December.
Turning to fiscal policy, Anand said Japan's fiscal management has "performed quite well," helped by higher tax revenue and spending control measures. Anand said fiscal improvement momentum is positive, and under the baseline scenario the ratio of government debt to gross domestic product is expected to decline.
He cautioned, however, that Japan's debt burden remains extremely high, with rising borrowing costs and an aging population adding pressure on spending, making prudent fiscal policy essential.
Since taking office, Sanae Takaichi has introduced multiple spending plans, including a two-year food consumption tax cut and a long-term investment plan for strategic industries, without clearly specifying funding sources. Uncertainty over funding sources, combined with other macroeconomic factors, pushed Japanese government bond yields to a 30-year high earlier this month.
The Japanese government is evaluating about 200 existing public funds and multiple tax incentives during the year-end budget process, aiming to cut inefficient spending and redirect funds to new projects. Although investors are skeptical about how much the government can save through this effort, Anand believes there is still considerable room for spending cuts. He said, "This is not fantasy; it can be achieved."
Anand also stressed that Japan needs a credible medium- to long-term fiscal framework to constrain spending commitments and give investors a clearer picture of Japan's debt trajectory. "A clear path of continuous decline in the debt ratio would also benefit the Japanese government bond market and other areas," Anand said.
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