Bank of Japan Holds Steady as December Hike Gains Momentum

The Bank of Japan will likely keep its policy rate at 1.25% when its two-day meeting concludes on Friday.

A survey of 16 economists and analysts, conducted by CNBC between October 14 and 26, found that all respondents expect the central bank to maintain the current rate. This level represents the highest benchmark rate in 31 years. Despite this pause, every participant in the survey indicated that the bank will set the stage for a rate increase in either December or January of next year.

The economic data supporting this tightening path shows core inflation, which excludes fresh food, rose by 2.1% in September compared to the same month last year. This marks the highest rate for the year. The increase is driven by a weak yen, which raises import costs, and elevated energy prices. Government subsidies are currently helping to absorb some of these rising costs for consumers.

Wage growth is also accelerating. Inflation-adjusted wages in Japan rose for the eighth consecutive month in August, climbing 1.5% from the previous year. This trend suggests that wage growth is beginning to drive inflation. Finance Minister Satsuki Katayama told lawmakers last week that Japan is on the cusp of entering a period of sustained inflation driven by rising wages. She acknowledged that higher import costs are also contributing to price increases.

Market participants are watching for specific language changes in the central bank's monetary policy statement. Reports from Reuters and The Japan Times suggest the bank will declare that its underlying inflation target of 2% has been met. Ryutaro Kimura, a senior fixed income strategist at BNP Paribas Asset Management, noted that he is waiting to see if the bank changes its phrasing from underlying inflation approaching 2% to having reached that level.

The outlook for the yen remains mixed. Nine respondents expect the currency to trade between 157 and 158 against the U.S. dollar over the next month. The three-month outlook is more scattered, with targets ranging from 150 to 160. Masahiko Loo, a senior fixed income strategist at State Street Investment Management, said that Japanese government bond yields and shifting capital flows should pull investment back to Japan. However, he noted that high U.S. yields will prevent a straight-line rally for the yen.

Bond yields are also expected to rise. Nine respondents forecast that the yield on benchmark 10-year Japanese government bonds will reach between 3% and 3.1% by year's end. This would be an increase from the current level of 2.809%. Seven respondents expect the yield on 30-year bonds to climb to 4% or 4.1%, up from 3.829% as of Tuesday.

Takuji Aida, chief Japan economist at Credit Agricole, believes the next rate hike is most likely to occur in January. That is when the Bank of Japan is scheduled to release its quarterly outlook report. Thirteen respondents in the survey expect the terminal rate, or the level where tightening stops, to be between 1.75% and 2% by mid-2027. Masato Koike, a senior economist at SOMPO Institute Plus, expects the bank to stop raising rates at around 1.75% to avoid excessive downward pressure on growth.