Bank of Japan to hold rate steady with likely upgrade to price view

[TOKYO]The Bank of Japan (BOJ) is expected to keep its benchmark interest rate steady and boost its inflation outlook on Thursday (Jul 31), as investors look for hints of another rate hike this year after a US-Japan trade deal reduced some uncertainty.

All 56 economists forecast Governor Kazuo Ueda’s board will leave the central bank’s interest rate unchanged at 0.5 per cent at the end of a two-day policy meeting, according to a Bloomberg survey this month. In the bank’s quarterly economic outlook report, the inflation projection for this fiscal year is likely to be revised higher, they said.

A primary focus for this gathering will be the extent to which the BOJ signals another rate hike this year, with traders now seeing a roughly 75 per cent chance of a move by year-end. BOJ officials see the possibility of mulling of another hike after Japan’s trade deal with the US diminished a key source of uncertainty, sources familiar with the matter said earlier.

With the key task of discerning the actual impacts of the tariffs still remaining, the BOJ will not be looking to suddenly hike rates at this point. Deputy governor Shinichi Uchida, a key policy architect at the bank, said last week that while the deal is a major breakthrough, uncertainty remains high.

Still, the search for rate hike hints from the BOJ is gradually gaining momentum, with October becoming more popular as the potential timing for the next increase. Last week, Deutsche Bank Securities and Barclays Securities both brought forward their calls to October.

The US and Japan unexpectedly struck a pact on Jul 22, setting most tariffs at 15 per cent. The lowering of auto levies from the 25 per cent that Trump imposed in April, in particular, is set to provide relief for a core part of Japan’s economy. That was followed by a similar agreement between the European Union and the US this week, easing concerns for the global economy.

The BOJ officials noted that the outcome of Japan’s negotiation was roughly within the range of their expectations and it’s probably unnecessary to make a drastic change to the central bank’s overall economic outlook, sources familiar with the matter said earlier.

In its April outlook report, the bank said that it expects economic growth to stall temporarily due to the tariffs, before picking up to bring underlying inflation to meet its goal sometime between October next year and March 2028.

BOJ watchers expect Ueda’s nine-member board to raise its median inflation forecast for this fiscal year to 2.5 per cent from 2.2 per cent, while keeping views for the following two years unchanged, according to a Bloomberg survey.

The pace of increases in the cost of living has stayed elevated, averaging 3.5 per cent in the first three months of the fiscal year that began in April. Inflation has been driven by a surge in food prices and in particular rice, the nation’s staple food.

Former BOJ chief economist Hideo Hayakawa said that firmness in prices will allow the bank to raise its inflation projection for next year, but the bank will likely keep it below 2 per cent to avoid fuelling too much speculation over a rate hike.

The Federal Reserve is set to announce its policy decision hours before the BOJ, and its conclusion and signals could have major implications for the course of the yen. As at Tuesday, the Japanese currency has dropped the most against the US dollar in the past three months among major currencies, as the Fed and the BOJ have both remained in a wait-and-see mode.

Following repeated warnings from US President Donald Trump that Japan should not seek a trade advantage via a weak currency, Ueda’s BOJ needs to strike a delicate balance to avoid sounding too cautious on raising borrowing costs.    

This is the first BOJ gathering after Prime Minister Shigeru Ishiba’s ruling coalition sustained a historic defeat in an upper house election on Jul 20, reflecting high public discontent over inflation. With his government now lacking a majority in either house of parliament, the Japanese leader has been confronting resignation calls from both ruling and opposition party members.

As with most other central banks, the BOJ typically does not comment on politics, but political instability could make navigating policy more complicated. After political parties pledged cash handouts or tax cuts ahead of the poll, the central bank will need to keep its eyes on the fiscal policy’s impact on inflation and bond yields.

Ueda usually holds a press conference at 3.30 pm to elaborate on the BOJ’s thinking after the release of a policy statement and economic forecast around noon.

Here are other key points to watch for

• Analysts will be watching the BOJ’s assessment of risk balance for inflation. The bank said risks are on the downside three months ago but price growth has been stronger than expected, they said.

• The board may replace and soften the term “extreme” in describing the level of uncertainty to reflect progress in trade talks around the globe. If the word is kept, it suggests the bank still remains very much on guard.

• Ueda sent a dovish signal at the post-meeting press briefing in June by stressing the need to look at hard data before mulling a rate hike. BOJ watchers will be paying attention to any subtle shifts in his tone. BLOOMBERG