Chief Economist of JP Morgan, Masaaki Kanno feels that Bank of Japan may end its zero rate policy and up rates by 25 bps. He also says that Bank of Japan may not opt for hikes for several months after this round.

Kanno expects the next rate hike from Bank of Japan by December. According to him, the liquidity situation in Japan will remain stable even after the rate hike.

Excerpts of CNBC-TV18's exclusive interview with Masaaki Kanno:

Do you expect Bank of Japan to hike interest rates by 25 bps?

I expect Bank of Japan to end its zero rate policy and raise its overnight core rate by 25 bps.

A lot of people have been speculating that they might not move this time around and differ it. But the language might suggest that they might move in the future. Why don't you belong to that camp?

All the economy indicators suggest that now the economy in Japan is in a good shape. Tanken's forecast of capex for FY06 was extremely strong. CPI is now 0.6% in YoY terms and the economy outlook is good. Senior politicians including Koizumi have sent a positive message to Bank of Japan to go ahead with a rate hike this month.

What do you expect Bank of Japan to do; a 25 bps hike each quarter? How will that impact liquidity within Japan?

Liquidity is already injected into the banking sector, which has been considerably down. After Bank of Japan ends its zero rate policy, probably in this month, then it will go slow. I think Bank of Japan will not do anything for the next several months. After Bank of Japan confirms that the economy is satisfactory and also in the external side, US-China economy is okay, then Bank of Japan will raise rates again. We believe that the second rate hike will take place in December.

There are people who believe that by the early part of next year, Bank of Japan might go up to 2.50% from a zero interest rate policy. Would you go with that?

Two and half per cent sounds little bit on the extreme but that presents a sort of neutral policy rate. But Bank of Japan can afford to be behind the curve, which means that it could reach that stage relatively slowly as inflation is not a real concern at the moment. In that sense, Japan could enjoy the luxury of going slow or fast depending on the incoming economic data.

What are the signals that you are picking up from the financial markets in Japan and other political parties?

The most important thing for Bank of Japan is what economy and prices look like in 1-2 years ahead. Unless the current market situation becomes volatile, I don't think that will be a real concern for Bank of Japan.

Do you expect to see severe tightening in terms of the money that has been going out from Japan into other asset classes?

First of all, even after Bank of Japan raises interest rates, Japan's monetary conditions will remain extremely easy. The real policy rate, which is defined as nominal over the core rate minus inflation rate will remain negative. So that is an extremely easy monetary policy. So we expect continued capital outflow from Japan and that is likely to result in a weak yen.

How connected are the Japanese rates with the rest of the world? How much of a bearing would US and European interest rates have on what Bank of Japan's eventual end game would be in the next 6-12 months?

Basically, the monetary policy of those individual countries are independent from each other and they maintain a flexible floating exchange rate system. But the issue is sort of an inflationary concern. Actually, US is the front-runner and Japan follows the US and the European countries. But to that extent, if the inflationary risk remains the same, then Japan does not have to rush as Japan's output gap has just closed.

So probably, we will see a continued decline in the unemployment rate that will finally lead to a rise in inflation rate. In that sense, the three Central banks share more or less similar concerns on the inflation rate. So we are likely to see more tightening by the G3 Central Banks but Japan will come last.

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