Economists predict Bank of Japan keeps rates at 1.25% before potential December hike

The Bank of Japan will likely keep its policy rate at 1.25% when its two-day meeting concludes on Friday, according to a survey of 16 economists and analysts. All respondents agreed that the central bank would maintain the current rate, which reached its highest level in 31 years following an increase last month.

Despite the hold, the market consensus points to further tightening in the near future. Every respondent expects the bank to set the stage for a rate hike in December or January of next year. This outlook is driven by persistent domestic inflation and rising wages. The bank is also expected to officially declare that its underlying inflation target of 2% has been met at this meeting.

Homin Lee, a senior macro strategist at Lombard Odier, stated that macroeconomic factors support additional policy tightening. However, he noted that the policy board may lack sufficient consensus for successive hikes due to fragility in the domestic bond market. Sosuke Nakamura, an economist at Citi Research, offered a more cautious view, saying he sees no clear signs of inflation accelerating to a degree that would justify consecutive rate hikes.

Inflation data supports the central bank's hawkish stance. Japan's core inflation, excluding fresh foods, rose 2.1% year-over-year in September, marking the highest level of the year. This increase is attributed to a weak yen raising import costs and elevated energy prices, even as government subsidies mitigate consumer costs. Additionally, inflation-adjusted wages rose for the eighth consecutive month in August, climbing 1.5% from a year earlier. Finance Minister Satsuki Katayama told lawmakers last week that Japan was on the cusp of shifting to a period of sustained inflation driven by rising wages.

Market forecasts suggest continued pressure on the yen and government bonds. Nine respondents expect the yen to trade between 157 and 158 against the U.S. dollar over the next month. Regarding interest rates, nine respondents project the yield on benchmark 10-year Japanese government bonds to reach between 3% and 3.1% by year-end, up from 2.809%. Seven respondents expect the 30-year bond yield to rise to 4% or 4.1% from 3.829%.

Takuji Aida, chief Japan economist at Credit Agricole, believes the next rate hike is likely in January, coinciding with the release of the bank's quarterly outlook report. Thirteen respondents in the survey estimate that the terminal rate for the current tightening cycle will be between 1.75% and 2% by mid-2027. Masato Koike, a senior economist at SOMPO Institute Plus, expects the bank to stop raising rates at around 1.75% to avoid excessive downward pressure on growth.

The survey was conducted from October 14 to 26. The next policy decision is scheduled for Friday, with the next major data release and outlook report expected in January.