Bank of Japan governor Haruhiko Kuroda has given his nod to the Japanese government to go ahead with a sales tax hike in April. Kuroda said after the Bank of Japan policy meeting that the world’s third largest economy is “recovering moderately.” Consumer prices rose at the fastest pace in five years in July. Kuroda warned that a delay will affect investor confidence in the country’s fiscal sustainability, and push government bond yields higher.

Bank of Japan

Sales tax hike to be a big blow to Japanese economy

Prime minister Shinzo Abe is likely to make a final decision next month. As expected, the Bank of Japan kept its monetary policy unchanged as the central bank aims to reach the 2% inflation target within two years. A sales tax hike will be a big blow to growth and consumption. Mr. Kuroda said that the Bank of Japan has monetary tools to deal with the blow caused by the tax hike.

However, there is little the BOJ can do if investors lose confidence in the country’s commitment to pay off its debts, report Takashi Nakamichi and Tatsuo Ito of The Wall Street Journal. And a tax hike could give investors such a vibe. If that happens, bond prices would tumble and interest rates will surge. That would hamper business as well as individual borrowing, pulling the economy back into turmoil. Then the Bank of Japan will have to boost its massive stimulus program once again.

Bank of Japan and Taro Aso support April tax hike

Prime minister Abe’s predecessor had passed legislation that sales tax will increase from 5% to 8% in April 2014, and then to 10% in October 2015. Shinzo Abe has the rights to abandon or delay the plan depending on economic conditions. The Bank of Japan chief Kuroda and finance minister Taro Aso have extended support for a sales tax hike in April. But several others including Abe’s advisers Etsuro Honda and Koichi Hamada have opposed the sales tax hike, saying that the economy isn’t strong enough yet to absorb such a blow.

Societe Generale analysts Takuji Aida and Kiyoko Katahira said in a research note to investors that Japan’s inflation and economic outlook is in line with the Bank of Japan expectations. They believe that the BOJ is unlikely to alter its current stimulus program unless there is a large external shock. Aida and Katahira said that when the prime minister Abe sits to decide on the sales tax hike, he is highly likely to announce some more stimulus measures to minimize the impact on the sales tax hike on the economy.