Analysts Project Bank of Japan Rate Hike in December, Rule Out October Move

What happened

A Bloomberg survey revealed that most economists now expect the Bank of Japan (BOJ) to deliver its next interest rate hike in December, with 83% of respondents projecting a raise from 1.25% to 1.50% at the December 18 meeting. This percentage marks a significant increase from the 35% who expected a December move in the previous month's survey, when January was the most popular pick. None of the surveyed economists anticipate a hike at the October 30 meeting. Two-thirds of respondents also expect the BOJ to continue raising rates every three months, up from 46% previously, suggesting a continuation of the tightening pace observed since September. The median forecast for the terminal rate in this cycle remained at 1.75%. The primary focus for the October meeting will be whether the BOJ declares that underlying inflation has reached its 2% target, something it has not done since 2013. Furthermore, politics remains a factor, with about two-thirds of economists believing that Prime Minister Sanae Takaichi's government has softened its stance on rate hikes, following a US call for Japan to abandon reflationary policies.

Why it matters

The expectation of a December rate hike, rather than October, provides the market with more time to adjust, but maintains pressure on the BOJ to clearly signal its intentions. A BOJ declaration that underlying inflation has reached 2% would be a historic milestone after 13 years of efforts and would solidify expectations for future rate increases. The maintenance of a quarterly tightening pace, as expected by two-thirds of economists, indicates a more gradual normalization of Japanese monetary policy. Politics, especially the government's stance on rate hikes and US influence, remains a key element, potentially impacting the perceived independence of the BOJ. The policy rate having entered the estimated neutral range (1.1% to 2.5%) after September's hike increases market interest in how high rates will ultimately go.

Market impact

• Interest rates and bonds: The expectation of a December hike, rather than October, may lead to a slight decrease in Japanese government bond (JGB) yields in the short term, as immediate pressure for a move subsides. However, confirmation of a 2% inflation declaration and the expectation of a December hike tend to push longer-term JGB yields higher, reflecting the prospect of a tighter and more sustained monetary policy.
• Dollar and FX: The yen (JPY) may experience a slight depreciation against the dollar in the short term, given the absence of an October hike. However, a hawkish BOJ statement on underlying inflation and confirmation of December hike expectations tend to strengthen the yen, as it signals a narrower interest rate differential with other economies, such as the US. Escalations in the Middle East that lift oil prices could pressure Japan's trade balance and, consequently, the yen, as an energy importer.
• Equities: Japanese equities may react cautiously to the prospect of higher interest rates, which can impact corporate financing costs. However, the signaling of a more robust economy, with inflation hitting its target, may offset some of this effect, especially for export-oriented sectors that benefit from a potentially weaker yen in the short term.
• Commodities: Higher oil prices, driven by Middle East tensions, could add inflationary pressure in Japan, strengthening the case for rate hikes, but also negatively impacting the country's trade balance.
• Brazil: The direct impact on Brazil is limited, but a stronger or weaker yen can indirectly influence global capital flows and risk appetite in emerging markets, including Brazil. The stabilization or tightening of Japanese monetary policy may contribute to a global scenario of higher interest rates, which tends to be less favorable for Brazilian risk assets.

What to watch

Investors should closely monitor the BOJ's statement and the quarterly outlook report at the October 30 meeting, especially any mention of underlying inflation reaching the 2% target. Board voting patterns will also be crucial, with any further dissent or a call for a hike by a hawkish member being a swing factor. Additionally, the evolution of oil prices and the geopolitical situation in the Middle East will continue to be important for Japan's inflation outlook and trade balance.

Scenarios

Base Case: The BOJ holds rates in October but signals that underlying inflation is at 2%, solidifying expectations for a December hike and a quarterly tightening pace, resulting in a stronger yen and higher JGB yields in the medium term. Risk Scenario: The BOJ adopts a less hawkish tone than expected in October, or underlying inflation is not declared to have reached 2%, leading to yen depreciation and less pressure on JGB yields, delaying tightening expectations.

Original source: ForexLive (InvestingLive). For information only, not investment advice.