In Japan, central bankers are fighting a different kind of battle—here's why

As the Fed struggles to contain inflation, Japanese central bankers are getting closer to declaring the end of their decades-long battle against deflation.

According to Bank of Japan (BOJ) Deputy Governor Shinichi Uchida, the world’s fourth-largest economy has made notable progress in fighting deflation—but the battle isn’t over yet.

“While we still have a big challenge to anchor the inflation expectations to 2%, the end of our battle is in sight,” Uchida said. “The labor market structure appears to have changed after the pandemic, and wages are likely to continue increasing.”

Japan’s annual inflation rate has remained above the BOJ’s target for 25 consecutive months, reaching 2.5% in April. As a result, the BOJ in March voted to raise interest rates for the first time since 2007.

After more than two years of rising prices, the BOJ is finally prepared to abandon its zero-inflation expectations—something that would have seemed highly unlikely not so long ago.

The Japanese economy fell into a deflationary spiral in the 1990s when the country’s property and stock market bubbles burst. Inflation flipped negative in 1999 as banks cut lending, prices fell further, and demand slowed.

As Japan prepares to declare the end of deflation, many Western countries are struggling to put a lid on inflation.

The Fed’s long inflation fight continues

Unlike Japan, it’s hard to feel confident about how the Fed will handle interest rates.

A few months ago, the U.S. central bank projected multiple rate cuts this year. Then, inflation bounced back, economic growth slowed, and the Fed had no choice but to go back on its word.

Now, Fed officials are giving mixed signals about the pace and timing of rate cuts—and whether they’re even coming at all. As a result, economic projections are all over the place and downright contradictory.

For example, FHN Financial chief economist Chris Lowe said two rate cuts are still likely this year, but there are huge caveats.

“We had nothing but bad news on the inflation front through the first quarter. [...] all of those inflation increases were too big to allow rate cuts,” he told Reuters.

Meanwhile, Goldman Sachs CEO David Soloman said he sees no rate cuts in 2024. The bank’s economists, led by Jan Hatzius, said, “We continue to see rate cuts as optional, which lessens the urgency.”

“Recent Fedspeak and the May FOMC minutes make it clear that the upside inflation surprises this year, coupled with solid activity, are likely to take rate cuts off the table for now,” said Bank of America economist Michael Gapen.

Despite the uncertainty, nearly two-thirds of economists in a May Reuters poll expect the Fed to cut rates in September, with a strong likelihood of a second cut a few months later.