The upcoming Bank of Japan (BoJ) rate decision has generated significant speculation among investors, leading to various expectations and scenarios. While there is a slight consensus favouring the BoJ’s policy board maintaining the overnight call rate between “around 0.00%-0.10%,” there is a nearly even chance of a 15 basis point hike, with the possibility of two rate rises by the end of the year.

Potential Changes Beyond Rate Hikes

Aside from the potential for higher borrowing costs, market watchers anticipate that the BoJ will reduce Japanese Government Bond (JGB) purchases over the coming years, a move that could occur independently of rate changes. The BoJ’s reputation for cautious decision-making underscores the complexity of their current situation. Izumi Devalier from Bank of America (BofA) suggests that despite market volatility, BofA expects a modest rate increase to 0.25%, driven by positive wage and price data and progress in underlying inflation.

Economic Volatility and Government Intervention

The volatility mentioned by Devalier pertains to significant fluctuations in the yen and domestic equity markets. Japan’s finance ministry has intervened to stabilise the currency, citing the adverse effects of excessive fluctuations on the economy. Finance Vice-Minister Masato Kanda emphasised readiness for 24-hour intervention if necessary.

Data-Driven Decision Making

Recent indicators support potential BoJ action, with national headline inflation at 2.8% year-on-year (y/y) and core inflation (excluding food and energy) at 2.2% y/y, both exceeding BoJ’s 2% target. Economic activity is expected to recover from a -2.9% y/y contraction in Q1, though Q2 figures, available mid-August, may influence some decision-makers to await updated assessments.

JP Morgan’s Ayako Fujita noted that stronger-than-expected wage growth and signs of recovering domestic demand pose upside risks to future inflation, potentially forcing the BoJ into more rapid rate hikes. The decision will test the BoJ’s policy response, with recent positive data boosting confidence in achieving the price target.

Concerns about slowing consumption affecting the rate decision were downplayed by BofA’s Devalier, who attributed early 2024 consumption weakness to supply-side shocks in the auto sector, with a more positive outlook for services.

BoJ staff are expected to revise their outlook report, with observers noting that the estimates will likely show lower growth and core inflation forecasts for FY2024.

Messaging from Governor Ueda

Despite frequent market disappointments from the BoJ, Rabobank suggested that Governor Kazuo Ueda will need to carefully balance his tone to avoid sharp yen depreciation, potentially signalling a future rate hike to mitigate any disappointment over steady rates this week.

JP Morgan’s Fujita concurred with such sentiment. “He likely will reiterate the policy to continue raising the policy rate toward neutral in response to gaining confidence, signalling to the market that additional rate hikes likely will come, albeit at a gradual pace. In this regard, the key issue we may need to pay attention to would be the level of the terminal rate that [he] has in mind and the time frame to get to that level.”

Observers noted that Prime Minister Fumio Kishida appeared to pre-emptively endorse policy action recently, stating that “normalisation of monetary policy will support Japan’s transition into the next economic stage.”

As the BoJ deliberates its next move, all eyes will be on Governor Ueda’s messaging and the nuanced adjustments to Japan’s monetary policy in response to evolving economic conditions.