The International Monetary Fund (IMF) said on Thursday that a rate hike by the Bank of Japan (BOJ) should be delayed until inflation expectations have recovered and the consumer price trend is firmly rising.
While praising the BOJ's policy for focusing on ensuring sustainable growth, IMF First Deputy Managing Director John Lipsky said it would be not be appropriate for the central bank to target asset prices, the so-called yen carry trades and currency moves.
The Washington-based institution also said Japan's economy has become strong enough to cope with a stronger currency, saying that if upward pressure emerged, Japanese authorities should let the yen rise.
Lipsky and other IMF senior officials are in Tokyo for the IMF's annual Article IV consultation discussions with Japan.
"Given the more subdued inflation outlook in the near term, and absence of worrisome financial imbalances, we think that a rate hike should be delayed until inflation expectations have recovered and the prospective CPI trend is firmly rising," the IMF said in a concluding statement of its mission.
As the economy steadily grew, the BOJ scrapped zero interest rates last year, raising the key overnight call rate target to 0.25% last July and to 0.5% in February. Rates have been on hold since then.
The IMF said it agreed with the BOJ that the central bank should raise rates gradually based on incoming data.
"The main challenge is to manage a return to a neutral monetary stance in the context of very low inflation," Lipsky told reporters.
Japan's core consumer price index (CPI), excluding fresh food prices, fell 0.3% in March from a year earlier. April figures are due out on Friday.
Despite tepid inflationary pressure, BOJ Governor Toshihiko Fukui has underlined the need to raise rates as the BOJ is wary about unwanted side effects from keeping rates low for long.
Some lawmakers are worried about a premature monetary tightening.
Shigeyuki Goto, head of the ruling Liberal Democratic Party's monetary policy panel, told Jiji news agency on Thursday that Japan would not be ready for a rate hike in July.
Many market players expect the BOJ to raise rates in the July-September period at the earliest.
On currencies, the IMF statement said it would not endorse intervention to strengthen the yen, which would be of uncertain effectiveness and could damage the credibility of policy by Japanese authorities.
"By the same token, we would symmetrically suggest allowing the yen to appreciate if upward pressures emerged, since the economy can now cope with a stronger currency."
The dollar hovered around 121.60 yen on Thursday, staying near a three-month high of 121.88 hit on Wednesday.
The IMF said it expected the world's second-largest economy would grow 2.3% in 2007 and 1.9% in the following year, taking into account latest economic indicators in Japan.
Japan's economy expanded an annualized 2.4% in January-March from the previous quarter, marking the ninth straight quarter of expansion on the back of robust exports and personal consumption.