Bank of Japan Deputy Governor: AI Demand Shock Impacts Neutral Interest Rate, but Uncertainty Remains

According to Zhitong Finance APP, Shinichi Uchida, Deputy Governor of the Bank of Japan, stated that artificial intelligence (AI) is driving a surge in demand, thereby exacerbating inflationary pressures and pushing up long-term interest rates, and its impact may further extend to the neutral interest rate.

In a speech on Monday, Uchida said: "First, this is a huge positive demand shock that has already put upward pressure on the economy and prices. Second, it may affect the supply side, for example, by improving productivity and promoting the accumulation of capital stock, which in turn may affect r-star."

r-star refers to the level of interest rates that, before taking inflation into account, neither stimulate nor restrain the economy. Essentially, the neutral interest rate is r-star plus the inflation rate. Uchida's remarks suggest that with the spread of AI, central banks around the world may initially be forced to raise their neutral interest rates, although its long-term effect remains uncertain.

Uchida pointed out that although the growing demand for AI has driven up related stock prices and caused a loosening in financial conditions, the large-scale issuance of bonds by technology companies has pushed up long-term yields, thereby tightening financial conditions. Similarly, over the longer term, the structural effects brought by AI may drive monetary policy in different directions.

Uchida said: "AI may rapidly render certain forms of human capital obsolete, especially those skills designed for intellectual labor. It may also impact social inequality, as those with more technical skills and stronger adaptability may benefit much more than others." He added that these conflicting impacts require careful study, and the overall effect of AI on r-star is still difficult to assess at this time. "We do not yet have a clear answer," he said.

Uchida made these comments as economists and market participants are trying to evaluate how quickly and to what extent the Bank of Japan will further raise interest rates. At its September meeting, the Bank of Japan raised its policy rate to 1.25%, and the market widely expects another rate hike before the end of the year.

The summary of opinions from the Bank of Japan's September meeting showed that some policymakers believe it is necessary to accelerate the pace of rate hikes or bring rates closer to the central bank’s “target” as soon as possible, increasing the possibility of further hikes. Most views believe that with rising inflationary pressures, it is necessary to continue raising borrowing costs after the September hike. One member was quoted as saying: "If signs of upward price deviation are observed, the central bank will need to accelerate the pace of rate increases." Another opinion stated: "It is desirable for the central bank to raise the policy rate to roughly the target level relatively quickly," to allow room to respond to unexpected economic developments.

These opinions highlight the committee's increasing focus on inflation risks, reinforcing the mainstream expectation of another rate hike this year. One member said: "Given the latest developments, we must consider the prospect that oil prices may remain high," suggesting caution about the continued impact of the Middle East conflict.

However, not everyone thinks conditions are ripe for rate hikes. Two dovish members of the nine-person committee, Toichiro Asada and Ayano Sato, opposed the September rate hike decision. The summary contains some opinions possibly from them, warning that weak consumption and sluggish growth in service inflation are reasons to maintain current policy. The summary also indicates that a representative from the Cabinet Office urged the Bank of Japan at the meeting to "carefully examine the cumulative effect of past rate hikes," highlighting concerns that higher rates may hurt the economy.

Meanwhile, some recently released macro data or surveys also support market expectations for Bank of Japan rate hikes. The Bank of Japan’s Tankan quarterly survey released earlier this month showed that the business sentiment index for large manufacturers rose to 24 in September from 22, improving for the sixth consecutive quarter and reaching the highest level in more than eight years.

The survey is one of the Bank of Japan’s most closely watched data points. The latest Tankan report shows that the resilience of Japanese companies continues. Strong global artificial intelligence demand has cushioned the impact of the Middle East conflict, keeping Japan's manufacturing PMI in expansion every month this year; rising real wages have supported non-manufacturing service demand. Against this backdrop, the latest survey may reinforce market expectations that the Bank of Japan will raise rates again before December.

In addition, as the effect of some temporary government measures fades, Tokyo's key inflation indicator has risen sharply. Data released last Friday by Japan’s Ministry of Internal Affairs and Communications showed that Tokyo's consumer price index excluding fresh food rose 2.7% year-on-year in September. This figure exceeds the economists’ median forecast of 2.3%, and is also higher than the 1.8% increase in the previous month. This is the first time since January that this indicator has reached 2% or above. This provides support for the Bank of Japan’s stance of continuing rate hikes as the authorities accelerate policy normalization.