Bank of Japan to hold rates, signal further hikes

TOKYO: The Bank of Japan (BOJ) is set to keep interest rates steady on Friday but stress its focus on preventing underlying inflation from overshooting its two per cent target, suggesting scope to raise borrowing costs as soon as December.

Such guidance would reinforce the central bank's message last month that it has entered a new, more hawkish policy phase and is open to raising rates once every few months, analysts said.

The shift would also align the BOJ with its US and European counterparts, which are eyeing near-term rate hikes to tackle inflationary risks from the artificial intelligence (AI) boom and the energy shock triggered by the Iran war.

"Global price pressures from AI investment are quite strong, which means the recent inflation is partly demand driven," said Kazuo Momma, a former BOJ executive who is currently executive economist at Mizuho Research Institute.

"By declaring that its policy phase has changed, the BOJ is essentially telling markets it will hike rates once a quarter," he said, predicting rate hikes in December and March next year.

At the two-day meeting ending on Friday, the BOJ is expected to maintain its policy rate at 1.25 per cent, foregoing a back-to-back hike to allow more time to scrutinise the impact of previous rate increases on lending conditions.

In its quarterly report, the BOJ is likely to slightly revise upwards its price forecast for the next financial year and signal that underlying inflation has roughly reached its 2 per cent target, people familiar with the matter told Reuters.

With wage gains becoming embedded and inflation expectations hovering around two per cent, the central bank is likely to stress that it will now focus on anchoring inflation around its target by raising rates towards levels deemed neutral to the economy.

Markets will scrutinise comments from Governor Kazuo Ueda's post-meeting news conference for clues on the pace and timing of further rate hikes.

"If the BOJ were to say underlying inflation reached levels consistent with its two per cent price target, that would have important policy implications," said former BOJ official Nobuyasu Atago, who is currently chief economist at Rakuten Securities Economic Research Institute.

"It would be a show of resolve the BOJ won't tolerate any further overshoot in inflation," and signal the possibility of more nimble rate hikes next year, he said.

With persistently high energy costs and rising import prices due to a weak yen adding to inflationary pressures, the BOJ raised rates in September after delivering an increase in June, a shorter interval than the roughly twice-yearly hikes in 2024 and 2025.

Most analysts polled by Reuters expect the BOJ to raise its policy rate to 1.5 per cent in December, followed by further increases next year. Their projections for the terminal rate centre around 1.75 to two per cent.

Annual core inflation in Tokyo, seen as a leading indicator of nationwide price trends, exceeded the central bank's two per cent target by a wide margin in October, data showed on Friday, highlighting mounting price pressures.

Rising prices could weigh on consumption as they prompt Japanese households, many of whom have never experienced widespread price increases in their lifetime, to seek discounts.

In its latest quarterly projections in July, the BOJ expected consumer inflation to accelerate in the coming months as firms continued to pass on rising costs.