Japan reaction: On hold for now

The Bank of Japan (BoJ) unanimously voted to maintain the short-term policy rate at “around 0.25%” at the September meeting but continued to signal that further hikes remained on the cards amid efforts to normalise monetary policy. Indeed, in the accompanying statement, the Board maintained that “Japan’s economy is likely to keep growing at a pace above its potential growth rate” as “a virtuous cycle from income to spending gradually intensifies”. It added that against the backdrop of an improved output gap, the underlying CPI inflation rate is expected to move towards a level consistent with the BoJ’s price stability target in the second half of the projection period toward 2026. The Bank also upgraded its guidance on the outlook for consumption noting that “private consumption has been on a moderate increasing trend despite the impact of price rises and other factors” a more upbeat prognosis than in the previous summary where it noted that “private consumption has been resilient”.

We think the BoJ are probably a bit too upbeat on the outlook for households, however, which will limit the path of tightening going forward. Indeed, household sentiment remains subdued in the face of higher prices, despite the recent rebound in real incomes, so we expect to see consumers saving at least some of the additional cash, even as real incomes continue to rebound over the next 12 months or so. In terms of inflation, a shallower path for consumption will make it harder for businesses to pass on higher wage costs and we therefore expect firms to have to absorb some of these rising costs.

Governor Ueda, meanwhile, sounded slightly more dovish in the press conference than in recent times. Indeed, while he continued to highlight that “Japan’s real interest rates remain extremely low” and that “if our economic and price forecasts are achieved, we will raise interest rates and adjust the degree of monetary support accordingly”, he flagged the downside risks stemming from the US economy for the first time. And political uncertainty amid the LDP leadership election will hold back the BoJ in the very near term, with the outcome announced next week, followed in all likelihood by a snap election. On balance, then, we think the BoJ will struggle to increase the policy rate by 25bp this year, instead waiting until Q1 2025, leaving the uncollateralized overnight call rate at 0.25% end-24 and 0.5% end-25.