The International Monetary Fund expects the Bank of Japan to raise interest rates one more times toward the neutral rate, while stressing the need to remain flexible on subsequent steps amid heightened global uncertainty, according to its mission chief for the country.

“Under our baseline, we are expecting one more rate hike to move the policy rate to neutral,” Mission Chief for Japan Rahul Anand said in an interview Friday.

With global uncertainty remaining elevated, Anand emphasized the importance of keeping monetary policy data-dependent and flexible.

Anand’s comments come as the BOJ gradually moves toward a neutral rate that the IMF continues to estimate at between 1.1% and 2.2%, with a central estimate of around 1.5%. The bank’s current policy rate of 1.25% is already within that range.

As they consider further tightening, BOJ officials are paying closer attention to underlying inflation. Governor Kazuo Ueda has said the trend is approaching the bank’s 2% target, while emphasizing the need to ensure inflation settles sustainably at that level. The central bank expects underlying inflation to reach a level consistent with its target within the next 18 months.

Anand expects inflationary pressures to persist as energy prices remain elevated and businesses pass on higher costs more frequently. He sees Japan’s inflation rising above 2% before converging back toward that level by the end of next year.

Markets are currently pricing in less than 5% probability of a rate increase when the BOJ’s board meets in two weeks, but 82% by the end of the year. Officials are leaning against a rare back-to-back hike while keeping open the possibility of another move as soon as December, according to people familiar with the matter.

Turning to fiscal policy, Anand said Japan has “done really well” on fiscal management, helped partly by stronger tax revenues and efforts to rein in spending. “The momentum has been good, and we expect debt-to-GDP to go down under the baseline,” Anand said.

Still, he cautioned that Japan’s debt burden remains exceptionally high, underscoring the need for fiscal prudence as rising borrowing costs and an aging population add to spending pressures.

Since taking office, Prime Minister Sanae Takaichi has rolled out a range of spending items, from a two-year consumption tax cut on food to a long-term investment drive targeting strategic industries, without spelling out how she will finance them.

That uncertainty over financing, alongside other macroeconomic factors, helped push Japanese government bond yields earlier this month to the highest in 30 years.

The government is reviewing roughly 200 existing public funds and a range of tax breaks as part of its year-end budget process, seeking to eliminate wasteful spending and redirect resources toward new initiatives.

While investors remain skeptical about how much the government can save through the exercise, Anand sees scope for meaningful savings. “It’s not inconceivable. It could be done,” he said.

Anand also stressed the importance of a credible medium- to long-term fiscal framework that anchors spending commitments and provides investors with greater clarity over Japan’s debt trajectory.

“Having a very clear path of debt-to-GDP declining over time will also help with the JGB’s market and other,” Anand said.