Japan eyes rate hikes as the Fed ponders rate cuts

Inflation is beginning to cool in the U.S, fueling hopes that the Federal Reserve may soon be in a position to cut interest rates.

But over in Japan, policymakers have the opposite problem: the cost of living is ticking up, and the central bank is under pressure to hike rates.

The latest figures from Tokyo show consumer prices rose by 2.8% in the year to May, an increase from the 2.5% year-on-year rise recorded in April.

Inflation has been above the Bank of Japan's 2% target for 26 months straight now—thanks largely to ballooning electricity costs.

This is a watershed moment, especially considering the world's fourth-largest economy had been grappling with deflation for decades with little success.

A tale of two monetary regimes

It's fascinating how differently the U.S. and Japanese central banks responded to Covid, exclusively from a monetary policy standpoint.

In the aftermath of Covid, the Fed rapidly hiked rates to a range of 5.25% to 5.5%. That's a 23-year high, and the cost of borrowing has been stuck at this level for 11 months.

By contrast, until very recently, Japan was the only country in the world to keep interest rates in negative territory.

In 2016, a reduction to -0.1% meant savers would be effectively penalized for leaving their cash in a bank, a policy meant to stimulate spending.

But against a backdrop of rising wages and hot inflation figures, the Bank of Japan hiked interest rates for the first time since 2007.

They currently remain within a range of 0% to 0.1%, pretty modest when compared with the U.S., but all eyes now are on what happens next.

Another rate hike in July?

Policymakers from the Bank of Japan will next meet at the end of July, with Governor Kazuo Ueda stating that another rate hike isn't off the table

One source told the Reuters news agency, "Given what's happening with inflation, interest rates are clearly too low. Much depends on upcoming data, but a July rate hike is a possibility."

A big contributor to Japan's current inflationary pressures is a weak yen, which drives up the cost of imports.

The surging price of raw materials has been painful for Japanese firms, with some having little choice but to increase prices paid by customers.

A poll last month by Teikoku Databank revealed that 35% of companies believe the yen's depreciation has hit their sales, with 63.9% warning it's had a negative impact on their profits.

One U.S. dollar currently fetches about 160 yen—a level that hasn't been seen since the early 1990s.

In both countries, central banks face a headache as they try to bring inflation to heel.

But in the months to come, Jerome Powell and Kazuo Ueda will be relying on different tools as they try to keep their economies strong.