IMF calls on Bank of Japan to hike interest rates at 'gradual' pace

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IMF expects central bank's policy rate to hit 1.5% in 2027

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Srinivasan says high rates could lead to spillover effects

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Says Japan committed to flexible foreign exchange regime

(Adds Srinivasan's comments, background in paragraphs 4-5, 7-12)

By Leika Kihara

WASHINGTON, Oct 24 (Reuters) - The International Monetary Fund welcomes the Bank of Japan's decision to raise interest rates in July, but further hikes should proceed at a gradual pace, a senior IMF official said on Thursday.

Krishna Srinivasan, the director of the IMF's Asia and Pacific Department, also said the global lender now expects the BOJ's policy rate - now at 0.25% - to reach 1.5% in 2027.

"Given balanced risks to inflation, further hikes in policy rates should proceed at a gradual pace," Srinivasan told a press briefing on the Japanese central bank's policy outlook during the IMF and World Bank annual meetings in Washington.

An increase in the Bank of Japan's policy rate could result in spillovers in the financial markets of other countries where Japanese investors hold large positions, Srinivasan said.

But the impact has been "pretty muted" so far because the Japanese central bank's decision has been well communicated and its policy shift has been gradual, he said.

The Bank of Japan ended its negative rates policy in March and raised short-term rates to 0.25% in July on the view Japan was making progress toward sustainably achieving its 2% inflation target.

BOJ Governor Kazuo Ueda has said the central bank will keep raising rates if the economy moves in line with its forecast. But he has also stressed the need to scrutinize global uncertainties, such as the U.S. economic outlook, in timing the next rate hike.

Japan's central bank is widely expected to keep monetary settings unchanged at its policy meeting next week. A slim majority of economists

polled by Reuters

expect it to forgo a hike for the rest of this year, though most expect one by March.

When asked about the yen's recent renewed slide, Srinivasan said Japanese authorities are "fully committed to a flexible exchange rate regime."

"The yen has been used as a funding currency for carry trades," which at times magnified swings in the Japanese currency in the past year or so, he added.

While a weak yen gives Japan's exporters a boost, it has become a source of concern for policymakers by hurting households and retailers through a rise in the cost of imported raw materials.

Japan last conducted a yen-buying intervention in late July to support its currency after it tumbled to a 38-year low below 161 per dollar. (Reporting by Leika Kihara; Editing by Paul Simao)