Japan risks return to stagnation without early rate hike, ex-BOJ policymaker says

By Leika Kihara

TOKYO, June 1 (Reuters) - Japan is on the verge of repeating the policy mishap that led to decades of economic stagnation as Iran war-induced inflation risks forcing the central bank to raise rates aggressively if it doesn't act on time, former Bank of Japan board member Makoto Sakurai said on Monday.

The energy shock triggered by the conflict has led policymakers to look at past experiences for a possible solution including BOJ Governor Kazuo Ueda, who flagged the two oil shocks in 1973 and 1979-1980 as among examples.

What Ueda did not mention was Japan's asset-inflated bubble, caused in part by the BOJ's heavy money printing from 1986 to combat a strong yen. It kept policy loose even as asset prices soared, before reversing course in 1989. A series of aggressive rate hikes led to the collapse of the bubble and was blamed for three decades of economic stagnation.

The BOJ risks making the same mistake if it keeps interest rates low for too long, thereby heightening the chance of being forced to hike aggressively as inflation fires up, said Sakurai, who retains close contact with incumbent policymakers.

"Given broadening price pressures from the Iran war, stagflation is inevitable," Sakurai told Reuters on Monday.

"There's a serious risk of the BOJ falling behind the curve. Forgoing a rate hike in June is unthinkable," he said.

The BOJ exited a decade-long, massive stimulus programme in 2024 and raised interest rates several times including in December. But its short-term policy rate remains low at 0.75% even as inflation exceeded its 2% target for four years.

After a slew of hawkish signals from the BOJ, markets are pricing in a roughly 80% chance of a rate hike to 1% in June.

The Iran war has complicated the BOJ's decision on the timing and pace of rate hikes, as higher energy costs fuel inflation while simultaneously squeezing an economy heavily dependent on oil imports.

GDP shows little sign?of a red-hot economy. While the economy rose an annualised 2.1% in the first quarter, analysts expect growth to slow as rising fuel costs and supply disruptions hurt corporate profits.

But inflationary pressures are building as the weak yen and labour shortages prod firms to push up prices.

While subsidies have kept core consumer inflation below the BOJ's 2% target in recent months, it will likely accelerate to around 3.5% from autumn as companies pass on rising costs from the war, Sakurai said.

Sakurai also pointed to early signs of a bubble in Japan's stock and property markets, which the central bank flagged as risks in a semi-annual financial system report in April.

Japan's Nikkei share average topped 67,000 for the first time on Monday, powered by AI-related shares, while land prices rose at their fastest pace in 34 years in 2024.

"If the BOJ holds reservations over raising rates now, it will be forced to do so at a rapid pace later and hurt the economy," Sakurai said. "We're only a step away from repeating the mistake that led to Japan's lost decades."

(Reporting by Leika Kihara; additional reporting by Takahiko Wada; Editing by Alexandra Hudson)