By Leika Kihara

TOKYO (Reuters) – The Bank of Japan (BOJ) expects the economy to progressively achieve its 2% inflation target next year, as indicated by Governor Kazuo Ueda on Wednesday, suggesting that an interest rate hike might soon occur.

However, Ueda cautioned about the implications of significant uncertainties regarding foreign economies, particularly the economic policies of the incoming U.S. administration led by President-elect Donald Trump.

Key aspects influencing the central bank's decisions include next year’s wage negotiations between Japanese companies and labor unions. Ueda emphasized, “The timing and pace of adjusting monetary accommodation will depend on developments in economic activity, prices, and financial conditions.” This suggests a commitment from the BOJ to elevate short-term rates from the current 0.25%. Analysts anticipate a potential rise to 0.5% in either January or March.

In March, the BOJ had concluded its negative interest rates and raised its short-term policy target to 0.25% in July, indicating a willingness to hike rates further, contingent upon projected wage and price movements.

Ueda noted improvements in consumption due to increasing labor shortages leading to wage growth. He highlighted Japan's gradual journey toward achieving the BOJ's price target following years of vigorous monetary stimulus. Presently, the BOJ aims to support economic stability through maintaining a policy rate lower than neutral levels, while also signaling potential rate increases if economic conditions improve.

“Our projection is that the virtuous cycle will further intensify, moving Japan's economy closer to a sustainable and stable 2% inflation rate alongside wage increases,” Ueda mentioned, discussing the outlook for 2025.

He observed a moderate rise in prices for various goods and services linked to wage increases, asserting that the sustainable accomplishment of the 2% inflation target is achievable.

Following prior remarks about awaiting further insights on Trump’s policy and domestic wage trends, Ueda's latest comments suggested a cautious stance, interpreted by investors as dovish, which weakened the yen significantly since July and prompted warnings from Japanese officials.

Ueda elaborated that Japan must ensure wages increase in alignment with the 2% inflation goal, stressing that large companies must share high profits with smaller firms and households to sustainably meet the BOJ's inflation target.

The BOJ will monitor how wage increases from small and midsize companies evolve through its branch network. The central bank's quarterly report on regional economic conditions is scheduled for January 9, likely providing insights on the nationwide distribution of wage hikes and influencing the BOJ’s policy decision expected on January 24.