After the US Rate Hike Comes Japan... The BOJ’s Complicated Calculations

Policy Rate Set for 0.25-Point Increase
Would Mark Highest Level in 31 Years
BOJ Faces Need for Additional Hikes
But Watches Long-Term Bonds Closely
"Caution Against Interpreting as Terminal Rate Hike Signal"

The U.S. Federal Reserve’s hawkish decision has complicated the calculations for the Bank of Japan (BOJ), which is set to decide on its policy interest rate on September 18th.

According to public broadcaster NHK on September 17th, the BOJ is holding a two-day Monetary Policy Meeting starting today to decide whether to raise the current policy rate of 1% to 1.25%. If an increase is approved, it would be the first time in three months since June, and the policy rate would reach its highest level in 31 years since 1995.

In the market, a quarter-point (0.25%) increase is already regarded as a given. Institutions such as SMBC Nikko Securities have analyzed that this rate hike is nearly 100% priced in. As a result, attention is shifting from whether the hike will happen to how quickly further increases may occur and where the final policy rate, or “terminal rate,” will settle.

On March 19, Kazuo Ueda, Governor of the Bank of Japan (BOJ), attended a press conference after concluding a Monetary Policy Meeting in Tokyo, Japan. The BOJ held the Monetary Policy Meeting over two days starting from the 17th to make a final decision on whether to raise the current benchmark interest rate from 1% to 1.25%. Tokyo, Japan – Photo by Reuters Yonhap News

However, the Fed’s hawkish move has complicated matters for the BOJ. This is due to continued yen weakening driven by the widened interest rate gap resulting from additional U.S. monetary tightening, as well as mounting inflationary pressure caused by high oil prices amid issues like the blockade of the Strait of Hormuz. In its July outlook report, the BOJ forecast that consumer price inflation in the second half of this year would exceed 2%, reflecting the impact of rising crude oil prices and yen depreciation. Last month, Japan’s crude oil import value soared by 58.7% year-on-year. Taking into account the increased import prices caused by a weaker yen and higher oil costs, the BOJ currently sees the need for an additional rate hike.

Nevertheless, the BOJ also needs to consider the rise in long-term interest rates. The yield on newly issued 10-year government bonds, a key long-term benchmark, surpassed 3% on September 15th, reaching its highest level since 1996. If the BOJ signals a rapid pace of future rate hikes under these circumstances, the market may set expectations for an even higher terminal rate, which could push long-term yields higher. Katsutoshi Inadome, chief strategist at Sumitomo Mitsui Trust Asset Management, told Reuters, "The market is split between those who believe the BOJ will lower bond yields by alleviating concerns about lagging inflation response and those who expect the terminal rate forecast to be revised upward, resulting in even higher interest rates."

On the 16th, a man was walking past the Bank of Japan (BOJ) building located in Tokyo. The BOJ will hold a two-day monetary policy meeting starting on the 17th to discuss interest rate hikes. Tokyo (Japan) = Reuters Yonhap News.

This has resulted in evident differences within the BOJ regarding the pace of interest rate increases. One BOJ source, speaking anonymously to TBS, said, "Since financial conditions remain accommodative, it is better to raise rates while we still can." On the other hand, another source commented, "Although the country’s GDP has remained positive due to net exports, domestic demand is weak," adding, "We do not see the situation as one where inflation is accelerating." In other words, given that inflationary pressure from domestic demand is not yet strong, there is no need to rush additional hikes.

However, some argue that the pace of rate hikes and the ultimate terminal rate should be considered separately. Toru Suehiro, chief economist at Daiwa Securities, wrote in a column that although Governor Kazuo Ueda may consider accelerating the pace of increases, this does not necessarily mean a higher terminal rate. If a rate hike is implemented this time, the gap between hikes will shrink from six months to three months, making the market perceive the BOJ’s rate hike pace as accelerating. However, this should not be interpreted as a signal that the central bank intends to raise the terminal rate itself immediately.

Ultimately, the key lies in how Governor Ueda articulates the future direction. Yukio Noguchi, professor emeritus at Hitotsubashi University, stressed in Weekly Diamond that instead of pre-committing to a future interest rate level, the BOJ should clearly explain how it assesses the current economic situation and what principles and risk judgments guide its actions. He added, "What the market needs right now is not a schedule for rate hikes, but the rationale behind BOJ’s decisions."

This content was produced with the assistance of AI translation services.