MNI POLICY: BOJ Hikes To Weather Sluggish Underlying CPI

While U.S. trade policy may weigh on the Bank of Japan’s internal assessment of underlying CPI from late this year into early 2026, policymakers do not expect it to derail its rate-hike path from the December meeting onwards, MNI understands.

In July’s Outlook Report, the BOJ noted a deceleration in the economy driven by tariffs would likely result in sluggish CPI, though it did not specify the timing. The bank expects the slowdown, weaker corporate profits and a worsening output gap to restrain price-setting and weigh on underlying inflation.

Even so, policymakers maintain that underlying CPI will remain generally consistent with the price stability target in the second half of the projection period from April 2026 to March 2028.

While the year-on-year increase in core CPI has slowed as the pass-through of higher costs wanes in line with the bank’s July projections, this has not pulled down the Bank's internal underlying inflation calculation. (See MNI POLICY: BOJ's Concerns Grow Over Slowing Price Hikes)

Inflation expectations among firms and households remain solid, according to the September Tankan and a BOJ consumer survey. The absence of a pronounced slowdown in underlying CPI inflation suggests expectations are proving stubborn, a key factor officials see supporting a further rate hike. Officials believe markets and media have overstated the risk that underlying inflation would soften as headline gains moderate.

Markets currently assign a 10% probability of a rate increase at this week’s meeting, and a 37% chance of a hike at the Dec 18-19 gathering. (See MNI BOJ WATCH: Board Likely To Hold, Dec Rate Hike Eyed) Traders are not fully pricing in a 25 basis point move to 0.75% until at least late Q1.

WAGE GAINS

Policymakers are focused on whether slower CPI and uncertainty around wage gains in fiscal 2026 could exert downward pressure on inflation expectations, which remain insufficiently anchored. Wage-backed corporate price-setting over the past three years has played a central role in firming households’ underlying inflation.

The BOJ is struggling to gauge the scale of next year’s wage settlements. For the first time, companies must decide pay increases despite declining profits as they struggle with a labour shortage. While Bank officials see wage growth continuing, backed by Tankan results, branch manager reports and persistent labour scarcity, they doubt gains will match those seen this year. 

Labour unions have stepped up demands heading into year-end, but executives’ wage intentions will not be clarified until early 2026. The uncertain trade environment and concern over slower growth could make firms more cautious.