Japan still expected to stick to hiking cycle despite PM Ishiba’s dovish turn

Despite dovish comments from Japanese Prime Minister Shigeru Ishiba leading to a sharp plunge in the yen, market analysts aren’t budging from their Bank of Japan policy expectations for the longer term.

The yen slid to as weak as 147.15 against the U.S. dollar after Ishiba told reporters that the current economic climate does not require an additional rate increase. The currency clocked its largest single-day decline since June 2022 during the session.

“I do not believe that we are in an environment that would require us to raise interest rates further,” Ishiba said on Wednesday after meeting with Bank of Japan Governor Kazuo Ueda — who leads the rate-setting committee at the bank. The prime minister’s comments marked a drastic change in tone compared with the messaging on his recent campaign trail.

“This shift is particularly notable as the prime minister has been a long-time critic of past Liberal Democratic Party administrations, including the late Abe Shinzo’s, whose ‘Abenomics’ was associated with monetary easing,” said Stefan Angrick, senior economist at Moody’s Analytics. 

“My money is still on a rate hike in October,” Angrick told CNBC, noting that the latest BOJ meeting minutes from September still held an optimistic view of the economy.

The futures market on Thursday implied less than a 50% chance that the BOJ could hike by 10 basis points before the end of the year, according to LSEG data.

On Thursday morning, BOJ board member Asahi Noguchi said that the central bank should continue its accommodative monetary policy for the time being. He noted that it will take a while to change the public’s perception that prices will not increase significantly in the future.

The Bank of Japan kept its benchmark interest rate steady at “around 0.25%” — the highest rate since 2008 — in September. On July 31, Japan’s central bank lifted its benchmark rate from its previous range of 0% to 0.1%. This came after the BOJ in March raised its policy rate for the first time in 17 years.

While BOJ board members were split over the future path of interest rates at the September meeting, the board noted that Japan’s economic activity and prices had been “developing generally in line with the Bank’s outlook.”

The BOJ is expected to next review interest rates on Oct. 30-31, when it will also provide updated quarterly forecasts for growth and prices. Another meeting is scheduled for December.

Ken Matsumoto, macro strategist at Crédit Agricole CIB, said the markets were expecting the BOJ to raise the policy rate again at the upcoming October meeting with the economic and inflation outlook on track. But, he said, Ishiba’s announcement Monday for a General Election due to held on Oct. 27 (which will decide which party is in control of the parliament’s lower house) has thrown that off course.

Matsumoto, meanwhile, added that he expects the BOJ to likely hike at the January meeting next year, not before. Mazen Issa, a fixed income strategist at MRB Partners, said his firm “would not rule out another rate hike by the end of this year, but if not, the BOJ will hike by early 2025.”

“We expect any further yen weakness will prove limited,” he said.

When the BOJ hiked rates previously in July, the move sparked the unwinding of the popular yen carry trade, which led to a sharp sell-off in global markets. A “carry trade” takes place when an investor borrows in a currency with low interest rates, such as the yen, and reinvests the proceeds in a currency with a higher rate of return.

Higher interest rates generally lead to a stronger yen, which can negatively impact Japanese stock markets, particularly those indexes dominated by exporters. A strong yen makes their exports less competitive in the global market.

The BOJ and the government have been operating with greater coordination since the spring, and are now trying to encourage a consolidation in the currency following the great yen carry unwind, said Issa.

“Fundamental story still suggests that the BOJ is on track to hike into 2025, while the timing should depend on three factors,” said Nomura’s Yujiro Goto.

A December rate hike by the BOJ is still possible — but only if the yen weakens further, the U.S. avoids a hard landing and the American economy remains stable even beyond the upcoming presidential elections in November, Goto told CNBC.

Mizuho’s executive economist, Kazuo Momma, echoed this view.

What the BOJ will do largely depends on developments in exchange rates, which are materially influenced by developments in the U.S. “If the yen stays stable or strengthens, the BOJ will probably wait at least until January 2025,” he said.