MNI BOJ WATCH: Board To Consider Hike, Maintain Half-year Pace

The Bank of Japan Board will strongly consider raising the policy rate by 25 basis points to 0.75% at the Dec 18-19 meeting, as officials judge economic and financial conditions clearly warrant the move unless an unexpected shock occurs, such as a weaker U.S. economy or a sharp fall in stock prices.

The Board last raised the rate 25bp in January, but has held steady throughout the year due largely to trade and geopolitical risks. (See MNI BOJ WATCH: Ueda Hints Bank Close To Hike; Wages Key) Markets give a move higher next week a 93% chance, following signalling from Governor Kazuo Ueda on Dec. 1, saying the bank would consider the pros and cons of raising the policy rate and make an appropriate decision at this month's meeting. (See MNI POLICY: Ueda Sharpens Dec Rate Hike, Risks Credibility)

While the final decision depends on information about fiscal 2026 wage hikes to be gathered by Monday, officials so far see no factors that would prevent a move higher. Smaller firms have not yet decided on wage increases given weaker profitability compared with major companies, but officials continue to expect that pay rises at large firms will filter through to smaller ones as labour shortages remain severe.

The BOJ is also expected to maintain its stance that it will consider additional rate increases only after monitoring the impact on the economy, inflation and the financial environment for around six months. Markets see the Board raising the rate to 1% by October at the latest. 

NEUTRAL RATE

Markets are focused on how the BOJ will refer to the neutral interest rate, estimated at 1-2.5%, as the next hike brings the policy rate close to the lower end of that range. Officials are concerned that markets may assume the bank is nearing its limit for tightening. 

However, like the Federal Reserve and the European Central Bank, the BOJ cannot precisely pin down the lower end of the neutral rate, nor can it determine underlying CPI inflation or the natural rate of interest with accuracy, as all are derived from models containing considerable error margins. Officials are concentrating on how a move to 0.75% will affect accommodative financial conditions over time, including bank lending, corporate bond issuance and capital investment. The bank must assess the degree of accommodation through incoming data, and it remains committed to a gradual approach to policy adjustment.

Inflation is decelerating year on year, though more slowly than the BOJ had expected. While rice price increases are moderating, overall levels remain elevated. Government measures to alleviate the impact of high prices are expected to lower headline CPI in the near term, helping real wages move toward positive territory. But officials judge that these measures will also stimulate private demand, supporting underlying inflation over the longer run.