By Leika Kihara
WASHINGTON (Reuters) - The Bank of Japan (BOJ) must tread cautiously in raising interest rates, as some indicators of inflation expectations remain short of its 2% target, the International Monetary Fund's Japan mission chief Nada Choueiri said on Friday.
Choueiri told Reuters that a weak yen had a net-positive impact on Japan's economic growth, and signaled the IMF's preference for the country to allow exchange rates to move flexibly.
"We continue to believe that flexible exchange rates have served the global economy well," Choueiri said in an interview during the spring meetings of the IMF and World Bank in Washington, when asked whether the yen's recent sharp falls gave Tokyo justification to intervene in the currency market.
"I firmly believe that all the countries of the G7, and this includes Japan, are committed to flexible exchange-rate regimes and appreciate the importance of a flexible exchange rate."
While a weak yen boosts exports, it has become a source of headache for Japanese policymakers, as it hurts consumption by pushing up imported fuel and food prices.
Japanese authorities have repeatedly threatened to step into the currency market to prop up the yen, though they have held off since the last intervention in late 2022.
Choueiri said Japan's consumption will likely strengthen in the second half of this year on expected "very strong" wage gains that are expected to spread to smaller firms.
"We are pretty confident about our expectations for a consumption revival," she said, adding that inflation was expected to reach the BOJ's 2% target in 2026 in a sustainable way.
The BOJ, as a result, will have room to increase interest rates, though the timing and pace of such a move would depend on upcoming data, given the various risks surrounding the economic outlook, she said.
Among the risks are the impact on Japan's exports from global fragmentation and geopolitical tensions, as well as uncertainty about the strength of domestic consumption, Choueiri said.
"We are fully in agreement with the approach of the BOJ to be gradual and to analyze the data as it comes in," she added.
"I think gradualism is really important," because the risks to growth and inflation were equally balanced, Choueiri said.
In March, the BOJ ended eight years of negative interest rates and other remnants of its unorthodox policy, marking a historic shift away from its focus on reflating growth with decades of massive monetary stimulus.
Many market players expect Japan's central bank to hike rates again sometime this year, with bets on the timing focused on July or the October-December period.
Choueiri said there were signs corporate and household inflation expectations were getting anchored around the BOJ's target. But she said indicators on market inflation expectations have yet to reach 2%.
"This is another reason for the BOJ to be cautious, as they have explained," she said. "We think it's the right thing to do."
(Reporting by Leika Kihara; Editing by Paul Simao)
