(Bloomberg) -- With traders betting that the Bank of Japan will almost certainly end its negative interest rate policy by early next year, focus is shifting to where policymakers see the nation’s “neutral” rate.

This theoretical rate that neither stimulates nor restricts the economy is likely somewhere in a wide range of 0.5% to 2%, according to analysts, setting a huge challenge for investors.

Because the neutral rate will guide the BOJ as it normalizes monetary policy, it will also provide a key reference point for market pricing of Japanese bond yields, with implications for investment flows into everything from US Treasuries to bonds from Europe and Australia.

Japan’s overnight index swap curve indicates there’s a 20% chance that the BOJ will end negative interest rates by the end of the year, and that possibility rises to 100% by April, according to data compiled by Bloomberg.

Former BOJ research chief Toshitaka Sekine sees the neutral interest rate at 1.8%, reflecting the central bank’s two-year outlook for inflation excluding fresh food and energy prices. A further uptick in 10-year sovereign yields may push up the neutral rate to 2%, he said.  

Eiji Maeda, another former director of the BOJ’s Research and Statistics Department, also said the neutral interest rate is around 2%, in an interview with the Nikkei published earlier this month. The central bank may end its negative rate policy by as early as January next year and raise it by 0.25% every six months after that, he was quoted as saying. That means it may reach around 2% in January 2028 if that pace is continued.

Yoshimasa Maruyama, chief market economist at SMBC Nikko Securities Inc., sees the neutral interest rate somewhere in a range of 0.5% to 1.5%. He predicts that the BOJ will begin the normalization process with an eye to raising rates to the lower limit of around 0.5%, a level that may be reached in one year.

Other Economists’ Views

Tetsufumi Yamakawa, chief economist at Barclays Securities Japan Ltd.

Assuming that Japan’s neutral real interest rate is -0.5% and the underlying tone of medium- to long-term consumer price index is at the 2% level, the neutral rate will eventually converge around 1.5%. For the time being, the BOJ is likely to gradually guide the short-term policy rate toward 0.5%-1.0%, which is below the same level.

Takeshi Yamaguchi, chief Japan economist at Morgan Stanley MUFG Securities Co.

While we believe that Japan’s inflation expectations have moved out of zero% or negative, we remain skeptical that the 2% price target has been fully anchored. Long-term expected inflation is around 1%, and the nominal neutral interest rate remains around 1%.

Ryutaro Kono, chief economist at BNP Paribas Securities.

Japan’s natural rate of interest is around minus 0.5%, so if 2% inflation takes hold, the policy rate will essentially need to be raised to around 1.5%. However, raising the policy rate to that level in Japan, where the zero-interest-rate policy has been in place for a quarter of a century, would put stress on the financial economy. If interest rate hikes do not keep pace with rising inflation, there would be a risk that lower real interest rates would trigger a spiral of yen depreciation and inflation.

Naka Matsuzawa, chief strategist at Nomura Securities Co.

1.8% is a bit too high as a neutral level. It is doubtful that the BOJ will be able to raise interest rates to the neutral level during this business cycle, and it will take a considerable amount of time for wage growth to increase sufficiently to anchor 2% inflation.

(Adds a chart and several analyst quotes.)

©2023 Bloomberg L.P.