Global Market: BOJ nears historic inflation milestone, shifts focus to rate hikes

Synopsis

The Bank of Japan is expected to declare its nearly 14-year battle to achieve 2% inflation successful while keeping interest rates unchanged at 1.25%. With wage growth and inflation expectations strengthening, policymakers may signal further tightening, potentially in December, as they balance persistent price pressures against economic growth and financial stability.

The Bank of Japan is likely to declare victory in its nearly 14-year battle to achieve its 2% inflation target at its policy meeting on Friday, while warning of the risk of prices overshooting the goal and signalling scope for another interest rate hike as soon as December, Reuters reported.

The anticipated shift in the central bank's assessment would mark a significant milestone in Japan's departure from decades of deflation and ultra-loose monetary policy. With wage gains becoming more firmly established and inflation expectations hovering around 2%, the BOJ is expected to increasingly focus on keeping inflation near its target through gradual monetary tightening.

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Such a hawkish assessment could reinforce expectations of further monetary tightening by major central banks by the end of the year, as robust demand linked to artificial intelligence and an energy shock triggered by the Iran war add to global inflationary pressures.

However, the BOJ is expected to avoid providing explicit guidance on the timing and pace of future rate increases as it weighs the risk of inflation accelerating against the potential disruption to financial markets from an early hike.

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At its two-day policy meeting ending on Friday, the BOJ is widely expected to keep its policy rate unchanged at 1.25%, according to people familiar with its thinking cited by Reuters. The decision would allow policymakers more time to assess how previous rate increases have affected lending conditions and economic activity.

In its quarterly outlook report, the central bank is also likely to slightly raise its inflation forecast for the next fiscal year and indicate that underlying inflation has broadly reached its 2% target, Reuters reported, citing people familiar with the matter.

BOJ Shifts Focus Towards Sustaining Inflation

The anticipated change in the BOJ's assessment would signal a transition from its long-running efforts to stimulate inflation towards ensuring that price growth remains stable around the target.

Governor Kazuo Ueda had already indicated a shift in the central bank's policy focus when it raised interest rates in September. The BOJ is now expected to emphasise the need to gradually move borrowing costs towards levels considered neutral for the economy, Reuters reported.

A neutral interest rate is one that neither stimulates nor restrains economic activity. Moving towards that level would allow the central bank to normalise monetary policy while avoiding an excessive slowdown in growth.

The shift represents a significant challenge for policymakers, who must now balance the need to contain inflation against the risk of tightening financial conditions too aggressively.

Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities, described the development as a historic moment for the BOJ, Reuters reported. She noted that the central bank's task had become more complicated as it moved from stimulating inflation to preventing it from rising excessively.

Muguruma said the BOJ would closely examine upcoming economic data and market movements before deciding whether to raise rates in December or delay the move until January.

Analysts polled by Reuters expect the central bank to raise its policy rate to 1.5% in December and subsequently maintain a pace of quarterly increases.

Loose Financial Conditions Leave Room for Further Hikes

The BOJ launched an aggressive monetary stimulus programme in 2013 under former governor Haruhiko Kuroda to pull Japan out of deflation and achieve sustained inflation of 2%.

Although the central bank ended its unconventional monetary easing framework in 2024, it continued to raise rates cautiously, arguing that underlying inflation remained below its target.

However, persistent energy costs and higher import prices stemming from a weak yen have intensified inflationary pressures, prompting the BOJ to accelerate the pace of monetary tightening.

The central bank raised rates in June and again in September, shortening the interval between increases compared with the roughly twice-yearly pace followed in 2024 and 2025.

At 1.25%, the BOJ's policy rate is now within the estimated neutral-rate range of 1.1% to 2.5% calculated by its staff. This has increased market attention on how much further borrowing costs could rise before monetary policy begins to significantly restrain economic activity.

Strong bank lending is likely to reinforce the BOJ's assessment that financial conditions remain accommodative, leaving room for additional rate increases, people familiar with its thinking told Reuters.

The central bank's challenge will be to determine how quickly it can raise borrowing costs without undermining economic growth or unsettling financial markets.

Global Central Banks in Focus

The BOJ's policy meeting comes amid a busy week for global central banks, with investors assessing the outlook for interest rates in the United States and Europe.

The US Federal Reserve is widely expected to leave interest rates unchanged at the conclusion of its two-day meeting on Wednesday, while the European Central Bank is also expected to maintain its policy rate at 2.5% on Thursday.

Against this backdrop, investors will closely watch the BOJ's inflation assessment and any signals on its future policy direction for clues about the global interest rate outlook.

A stronger warning about inflation risks could strengthen expectations of a December rate hike, even if policymakers refrain from offering an explicit timetable for further tightening.

For the BOJ, Friday's meeting could therefore mark a turning point: the end of its prolonged campaign to generate inflation and the beginning of a more delicate effort to keep price growth under control.

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