BOJ to raise interest rates to 1.5% under Ueda, ex-central bank policymaker says

By Leika Kihara

TOKYO, Dec 22 (Reuters) - The Bank of Japan will likely raise interest rates three more times to 1.5% during Governor Kazuo Ueda's remaining term through early 2028, former central bank board member Makoto Sakurai told Reuters on Monday.

The first hike to 1.0% could come around June or July next year depending on the strength of the U.S. economy, as well as domestic wage and price developments, Sakurai said.

Further rate increases could become more challenging as they would ?bring borrowing costs closer to levels deemed neutral to the economy, and draw criticism from reflationist advisors of dovish premier Sanae Takaichi, he said in an interview.

"The BOJ won't say so publicly ?but probably sees 1.75% as the estimated neutral rate level. A hike to 1.5% would be comfortably below that level, and still ?leave the BOJ enough room to cut rates if needed," said Sakurai, who retains close contact with ?incumbent policymakers.

The BOJ may raise rates ?twice during the next fiscal year beginning in April 2026 if solid U.S. growth underpins Japan's economy, and domestic inflation remains above the central bank's 2% target, he said.

If uncertainty ?over the U.S. economic outlook heightens and domestic inflation moderates significantly, the BOJ ?could opt to hike rates just once in fiscal 2026 and delay further hikes until 2027, Sakurai said.

"The BOJ probably wants to resume rate hikes at a pace of about once every six months. But it seems a ?bit worried about the risk of facing pushback from the administration," ?he said.

"That may ?have been behind Ueda's ambiguous communication."

The BOJ raised interest rates to 0.75% from 0.5% on Friday, taking borrowing costs to a level unseen in 30 years in another landmark step towards ending decades of huge monetary support.

The hike to 0.75% pushes ?the BOJ's policy rate closer to the bottom of its estimated 1.0%-2.5% range of Japan's neutral rate, or the rate that neither cools nor stimulates the economy.

While Ueda said there was some distance before the policy rate reached the bottom of the estimated range, he gave no clarity on how many hikes would actually take rates to neutral.

GOVERNMENT SPENDING PACKAGE COULD BACKFIRE

Markets sold off the yen on the view the BOJ was in no rush to raise rates further, drawing warnings of yen-buying intervention from the government fretting about the inflationary effect of a ?weak currency.

The BOJ ?likely made progress getting consent to proceed with policy normalisation from Takaichi and Finance Minister Satsuki Katayama, including Friday's rate hike to 0.75%, Sakurai said.

"As long as the premier and finance minister give consent, the BOJ should face no problem ?hiking rates," he said. "But as rates get closer to neutral, things could get complicated."

Japan has seen inflation exceed the BOJ's 2% target for nearly four years, as companies pass on rising raw material costs and keep hiking pay to deal with labour shortages.

The BOJ's "tankan" survey showed companies project inflation to hit 2.4% one, three and five years from now - a sign inflation is becoming embedded in Japan's economy, Sakurai said.

He said Takaichi's big spending package, aimed at cushioning the blow to households from rising living costs, could backfire by accelerating inflation.

The administration's expansionary fiscal policy also risks eroding market trust in Japan's finances, thereby triggering ?a spike in bond yields and unwelcome yen falls.

"The yen weakened even after the BOJ's rate hike in December, which shows the currency's weakness is driven more by market concern over Japan's fiscal policy," Sakurai said.

Under Ueda, the BOJ exited a massive, decade-long stimulus last year and raised rates three times including to 0.75% last week, on the view ?Japan was making progress in durably hitting its 2% inflation target. His five-year term ends in April 2028.

(Reporting by Leika KiharaEditing by Shri Navaratnam)