Japan’s long-running reflation strategy is entering a new phase as inflation and wage growth become increasingly established. Asahi Noguchi, a former Bank of Japan (BOJ) board member who once supported aggressive monetary easing, now argues that Japan has moved beyond the conditions that justified prolonged low interest rates and large-scale fiscal stimulus.

Inflation and Wage Growth Change Japan’s Policy Equation

Noguchi said underlying inflation is now close to the BOJ’s 2% target, while wage growth has become sufficiently embedded to support price increases around that level. If those trends continue, additional policies designed to stimulate demand could create new risks rather than provide necessary support for the economy.

The shift is significant because Noguchi joined the BOJ board in 2021 as a prominent advocate of reflationary policies. He opposed the central bank’s decision to end negative interest rates in 2024 and also opposed a rate increase to 0.25% that year. He later supported two rate increases, reflecting the changing economic environment as inflation and wages became more persistent.

BOJ Rate Expectations Move Higher

Noguchi expects the BOJ to continue its gradual normalization of monetary policy. He sees a strong possibility that the central bank will raise its policy rate to 1.5% in December from the current 1.25%, while the eventual rate could reach 1.75% or even 2%, depending on U.S. monetary policy and developments in the Middle East.

The potential impact of higher rates is becoming an increasingly important consideration for Japan. Noguchi believes the economy could absorb a rate of around 1.75%, but a move to 2% could create a more significant shock for households and companies that have operated for decades in an environment of exceptionally low borrowing costs. The BOJ’s recent rate increases have already accelerated the process of normalization.

Yen Weakness and Fiscal Spending Add Pressure

Japan’s currency and bond markets are also becoming central to the debate. The yen has remained weak, increasing the cost of imported goods and adding to inflationary pressure. At the same time, concerns surrounding large government spending plans have contributed to greater scrutiny of Japan’s fiscal position and government bond market.

Noguchi argues that Japan’s positive output gap means excessive fiscal expansion is no longer necessary. Additional spending could push bond yields higher and crowd out private investment, while interest rates that remain too low could encourage further yen depreciation. Together, those pressures could make it more difficult for policymakers to contain imported inflation without tightening financial conditions more aggressively.

The next phase of Japan’s economic policy will depend on whether inflation and wage growth remain durable without additional fiscal stimulus. Markets will closely monitor the BOJ’s December decision, the yen’s movement against the dollar, Japanese government bond yields and developments in global interest rates. The challenge for policymakers will be to normalize rates gradually enough to avoid a sharp economic shock while preventing renewed currency weakness and inflation from undermining price stability.