BOJ: Rates Expected to Hold, But Inflation Signals Could Open Door to December Hike

What happened

The Bank of Japan (BOJ) is expected to keep its interest rates unchanged at its October meeting, according to Daiwa Securities' preview. However, the decision could mark an important shift in the central bank's policy thinking. Daiwa anticipates the BOJ board will conclude that underlying inflation has reached 2%, which would represent a transition from a phase of lifting inflation towards its target to one focused on stabilizing it around that level. While October surveys indicate an easing of inflation expectations among households and businesses, concern about an inflation overshoot remains high, driven by rising crude oil prices reigniting upstream price pressures.

Governor Kazuo Ueda has already signaled this change in tone, stating that with underlying inflation now close to 2%, the bank can no longer tolerate further increases and aims to stabilize it. Daiwa expects the BOJ's Outlook Report to replace its description of inflation as 'approaching 2%' with wording that it is 'broadly consistent with the target'. One board member, Hajime Takata, may again propose a rate hike, citing strong global demand. Conversely, Naoki Tamura, who has advocated for gradual increases, is seen supporting a hold so soon after September's hike.

Why it matters

The BOJ's rate hold is largely expected, but the language used and updated projections will be crucial for markets. A formal declaration that underlying inflation has reached 2%, a dissenting vote from Takata, and any indication from Governor Ueda about potential action at the 'next meeting' would be interpreted as hawkish policy signals. This suggests the BOJ would be moving from a stance of combating deflation to one of managing price stability, with the risk of a December rate hike.

Conversely, a more guarded stance from Ueda, emphasizing a broad review of financial conditions and without clear signals of an imminent move, could lead markets to trim December hike expectations. The trajectory of crude oil prices is a key upside risk for inflation, with the potential to accelerate cost pass-through into next year, fueling the BOJ's concern about inflation overshooting its target.

Market impact

• Interest rates and bonds: If the BOJ signals a more hawkish stance (underlying inflation at 2%, dissent, or 'next meeting' mention), short-end Japanese government bond (JGB) yields are likely to rise as markets price in a higher probability of a December hike. A more cautious Ueda, on the other hand, could lead to a trimming of December hike expectations and, consequently, a fall in yields.
• Dollar and exchange rates: A hawkish tone from the BOJ, indicating a potential December rate hike, tends to strengthen the yen (JPY) against the dollar and other currencies. This is because higher interest rates make the yen more attractive to yield-seeking investors. A more cautious tone, diminishing hike expectations, tends to weaken the yen.
• Equities: A scenario of faster monetary tightening in Japan, while potentially seen as a sign of a stronger economy, could also raise concerns about the cost of capital, potentially putting pressure on Japanese equities. However, the direct impact on global equities may be limited unless there is a significant surprise.
• Commodities: Rising crude oil prices are mentioned as a key upside risk for inflation. If the BOJ expresses greater concern about commodity-driven inflation, this could indirectly influence global demand expectations, although the direct impact is more on Japanese monetary policy.

What to watch

Investors should closely monitor the BOJ's policy statement, the Outlook Report, and, crucially, Governor Ueda's press conference. Key details to watch include:

• Language on underlying inflation: whether the BOJ formally declares it has reached 2%.
• Dissenting votes: the occurrence of a dissenting vote from Hajime Takata in favor of a hike.
• Ueda's rhetoric: any shift from 'every meeting' language towards 'next meeting' when discussing future policy actions.
• Updated projections: especially forecasts for FY26 GDP growth and FY27 core CPI.

Scenarios

Base Case: The BOJ holds rates, but the statement and Ueda's language suggest underlying inflation has reached 2%, keeping the door open for a December hike without an explicit commitment. The yen and short-end JGB yields react with a slight increase. Risk Scenario: Ueda adopts a more cautious stance, emphasizing a broad review of financial conditions and downplaying the urgency of a December move. Hike expectations are trimmed, and the yen and short-end JGB yields may weaken.

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