Bank of Japan cautiously upbeat on US outlook, warns of jittery markets

By Leika Kihara

WASHINGTON (Reuters) -Bank of Japan Governor Kazuo Ueda said on Thursday optimism over the U.S. economic outlook was broadening but markets remained unstable, offering a mixed view on whether risks to his country's economy were subsiding.

Ueda's comments on the U.S. economy and markets have come under scrutiny after he recently highlighted uncertainty over a U.S. "soft landing" and jittery markets as key risks that required Japan's central bank to go slow in raising interest rates further.

"Optimism over the U.S. economic outlook appears to be broadening somewhat," Ueda said in a press conference after attending the Group of 20 finance leaders' gathering.

"But we need to analyze further whether this optimism would be sustained, or prove temporary," he said, adding that the Bank of Japan can afford the time to scrutinize risks to the economy in deciding when to raise rates again.

Ueda also said markets remained unstable with implied volatility still "quite high," suggesting the central bank was not letting its guard down against the risk of renewed volatility.

When asked how recent drops in the value of the yen could affect inflation, Ueda said the Bank of Japan must look not just at currency moves but factors driving them, such as shifting perceptions of the U.S. economy.

"Recent yen falls are caused partly by increased optimism over the U.S. economy," he said.

Japan's central bank is widely expected at a two-day policy meeting next week to keep its short-term policy rate steady at 0.25% and roughly maintain its forecast of inflation hovering around 2% through March 2027.

It ended its negative rates policy in March and delivered a rate hike in July on the view that the country was making progress toward sustainably achieving its 2% inflation target.

Ueda has said the central bank will keep raising rates if the economy moves in line with its forecast. But he has also stressed the need to scrutinize global uncertainties, such as the U.S. economic outlook, in timing the next rate hike.

A slim majority of economists polled by Reuters expect it to forgo a hike this year, though most expect one by March.

MORE YEN TALK

Receding expectations of aggressive interest rate cuts by the Federal Reserve, coupled with the prospect of prolonged low borrowing costs in Japan, have kept the yen under pressure.

After rebounding from a three-decade trough near 162 to the dollar in early July, the yen resumed its decline to around 153 this week in a fresh headache to policymakers worried about the hit to the economy from rising import costs.

Japanese Finance Minister Katsunobu Kato, who also attended the G20 gathering in Washington, on Thursday issued a fresh warning against currency speculation.

"I told the G20 meeting that volatility remained high in the currency market," Kato said in a press conference. "I also said authorities must be vigilant to the spillovers of each G20 member's macroeconomic policy, and excessive exchange-rate volatility caused by speculation," he said.

Rising interest rates in Japan, which has been a supplier of cheap funding across the world, will have huge repercussions on global markets. The Bank of Japan's rate hike in July caused a huge unwinding of yen carry trades that jolted markets.

The IMF on Thursday urged Japan's central bank to proceed with rate hikes at a gradual pace, given the potential magnitude of such moves on the global economy.

(Reporting by Leika Kihara; Editing by Andrea Ricci and Paul Simao)