Bank of Japan is preparing to take action, and any respite for the yen may be temporary, as domestic and international factors have complicated the future interest rate hike timeline.
The Bank of Japan’s monetary policy committee will hold a meeting from January 23 to 24. The committee will announce its decision at the end of the review.
The Bank of Japan ended years of negative interest rates in March of last year and raised its short-term policy target to 0.25% in July. The central bank has indicated that it is prepared to hike rates again if wages and prices move as expected.
There is increasing internal belief within the Bank of Japan that the conditions for another rate hike are in place, as the economy continues to expand moderately, and inflation has remained above the 2% target for nearly three years.
Businesses are continuing to pass rising raw material and labor costs onto consumers, suggesting that the Bank of Japan may raise its inflation forecasts in the quarterly outlook report to be released next week.
More importantly, there are growing signs that companies will offer significant pay raises for the third consecutive year in the annual wage negotiations starting in March.
Managers of regional branches of the Bank of Japan have noted that pay increases are expanding across companies of various sizes and sectors, meeting a key prerequisite for raising rates.
Thus, the Bank of Japan may raise rates to 0.5% next week unless Trump causes market turmoil.
The Bank of Japan's views on wages and U.S. policy prospects have been closely watched by the market. Last month, Governor Kazuo Ueda stated that uncertainty around domestic wage prospects and Trump’s policies were reasons for delaying rate hikes.
In a speech on Tuesday, Deputy Governor Masayoshi Amamiya remarked that wage growth this year could remain strong. A day later, Ueda echoed this optimism, indicating that the Bank of Japan is confident Japan is moving toward sustainably achieving its inflation target.
Both Amamiya and Ueda stated that the Bank of Japan would discuss the possibility of raising rates next week, suggesting a high likelihood of such an action.
With the likelihood of continued wage growth increasing, the only obstacle to a rate hike next week would be the risk of Trump’s unexpected statements disrupting financial markets.
In addition to his inaugural address, Trump is expected to issue a series of executive orders starting Monday as he begins his second term in the White House.
Amamiya indicated that he would be looking for clues regarding the “balance and timing” of U.S. government policies, as well as anything that Trump has yet to clarify.
If Trump’s remarks are surprising and lead to a global market sell-off, the Bank of Japan may prefer to stay put until the markets digest the news.
Diminished bets on further rate cuts by the Federal Reserve mean that the interest rate differential between the U.S. and Japan will continue to widen, placing downward pressure on the yen.
While a rate hike by the Bank of Japan could boost the yen, unless Ueda makes hawkish comments about the outlook at the post-meeting press conference, any rise in the yen may be short-lived.
The Bank of Japan will release its quarterly outlook report, which will include revised growth and inflation forecasts. This will indicate the committee's level of optimism regarding Japan's sustainable achievement of the 2% inflation target, influencing the pace of future rate hikes.
Ueda may also provide hints about the timing and pace of further rate increases during the post-meeting briefing.
A key point of interest is his view on Japan's neutral interest rate. Bank of Japan staff estimates suggest that the inflation-adjusted real neutral interest rate is around -1% to 0.5%. This implies that if the inflation rate reaches the Bank of Japan's 2% target, the central bank could increase short-term rates to at least around 1% without stifling growth.
According to forecasts made last October, the Bank of Japan expects short-term rates to approach its perceived neutral level during the “latter half of the three-year forecast period” before March 2027, which means sometime after October 2025.
While hawkish committee member Naoki Tamura expects the neutral rate to be around 1%, Ueda has stated that it is difficult to arrive at a reliable estimate due to a lack of data.
Many analysts anticipate that the Bank of Japan will continue to raise rates at a pace of about twice a year. If the Bank of Japan raises rates next week, it may adopt a wait-and-see approach until the impacts of Trump’s policies become clearer in the second half of the year.
Domestic politics also complicate the Bank of Japan’s rate hike timeline. The Bank of Japan is set to hold a Senate election in July, where Prime Minister Shigeru Ishiba’s minority coalition may struggle to secure votes. Until the election dust settles, the Bank of Japan may be inclined to avoid changing its policy.
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