IMF Urges Japan to Hike Rates, Avoid Tax Cuts

The International Monetary Fund on Wednesday called on Japan to continue raising interest rates and refrain from loosening fiscal policy, adding that cutting the consumption tax would “erode fiscal space and add to fiscal risks.” The advice comes after Prime Minister Sanae Takaichi’s landslide win and her pledge to suspend the 8% food tax for two years, raising concerns about potential pressure on monetary policy. The global lender also stressed the Bank of Japan’s “continued independence and credibility,” saying it is “appropriately withdrawing monetary accommodation” and that gradual hikes should move rates toward neutral by 2027. The Bank of Japan ended its stimulus in 2024 and lifted rates to 0.75% in December, a 30-year high. With inflation above 2% for nearly four years, the IMF expects two more hikes this year and another in 2027. It also welcomed Japan’s commitment to a flexible exchange rate, saying it would help absorb external shocks and maintain price stability.

Further interest rate hikes will be necessary to complete Japan’s monetary policy normalization, central bank board member Kazuyuki Masu said in a speech on Friday. Masu noted that raising rates would help reduce the policy divergence between Japan and other major economies, a gap widely seen as a key driver of prolonged yen weakness that has pushed up import costs for businesses and households. Masu stressed that policy tightening must be handled carefully. He said timely and appropriate rate hikes are needed to keep underlying inflation below 2%, while warning against raising rates too aggressively in a way that could disrupt the gradual upward trend in wages and inflation. The speech was Masu’s first public appearance since joining the Bank of Japan’s nine-member board last July, when he characterized his stance as balanced between hawkish and dovish views.

The Bank of Japan’s risk of falling behind the curve has not increased markedly, a summary of opinions at its January meeting showed. Still, careful and timely policy execution is seen as increasingly vital. With real interest rates still deeply negative, and assuming the central bank’s outlook for activity and prices holds, further rate hikes are considered appropriate. The board is gauging each move’s impact on growth, inflation, and financial conditions, pursuing gradual tightening, though policy remains highly accommodative amid yen weakness Underlying inflation has moved closer to the 2% target, supporting the case for continued adjustments. Looking ahead, shifts in overseas rate environments could heighten the risk of lagging policy. Japan’s real policy rate remains the lowest globally, and forex markets’ sensitivity to rate differentials underscores the need to narrow the gap. Yen weakness and rising yields largely reflect fundamentals, leaving timely hikes as the key response.