BOJ Expected to Keep Rates at 0.5%, Inflation Forecast May Rise

The Bank of Japan (BOJ) is set to announce its interest rate decision and economic outlook report this Thursday. Market consensus points to the BOJ keeping its benchmark interest rate at 0.5%, with a potential upward revision to its inflation forecast for the current fiscal year. This anticipation comes as the recent U.S.-Japan trade agreement has reduced some uncertainties, prompting investors to search for signs of further rate hikes this year.

The primary focus of this meeting is whether the BOJ will raise interest rates again this year. Currently, the market estimates a 75% chance of a rate hike by the end of the year. Following the U.S.-Japan trade agreement, which eliminated a key uncertainty, BOJ officials may consider another rate hike. However, the BOJ is not expected to suddenly raise rates due to the need to assess the actual impact of tariffs. The BOJ's deputy governor recently stated that while the agreement is a significant breakthrough, uncertainties remain high.

Market expectations for another BOJ rate hike have intensified, with October emerging as a potential timeline for the next hike. Last week, several major banks, including Deutsche Bank Securities and Barclays Securities, advanced their rate hike predictions to October. The U.S. and Japan unexpectedly reached a trade agreement on July 22, setting most tariffs at 15%. This agreement, along with a similar one between the EU and the U.S., has eased global economic concerns.

Insiders reveal that BOJ officials view the negotiation results as largely in line with expectations, suggesting that significant adjustments to the overall economic outlook may not be necessary. In its April outlook report, the BOJ projected that economic growth would temporarily stall due to tariff impacts but would later rebound, allowing the potential inflation rate to reach its target level between October 2024 and March 2028. The BOJ's inflation expectations are lower than those of economists.

Observers anticipate that the BOJ will raise its average inflation forecast for the current fiscal year from 2.2% to 2.5%, while keeping the forecast for the next two years unchanged. The BOJ's former chief economist noted that strong prices will enable the BOJ to raise its inflation forecast for next year, but the bank may keep the inflation rate below 2% to avoid excessive speculation about rate hikes.

The Federal Reserve is scheduled to announce its interest rate decision a few hours before the BOJ, and its conclusions and signals could significantly impact the yen's trajectory. As of Tuesday, the yen against the dollar hit its largest three-month decline, with both the Fed and the BOJ adopting a wait-and-see approach. Following multiple warnings from U.S. President Donald Trump that Japan should not gain trade advantages through currency devaluation, the BOJ must strike a delicate balance to avoid appearing overly cautious in raising borrowing costs.

This BOJ meeting is the first since the ruling coalition led by Prime Minister Fumio Kishida suffered a historic defeat in the July 20 House of Councillors election. The election reflected strong public dissatisfaction with inflation. With the Kishida government currently lacking a majority in both houses of parliament, the leader faces calls for resignation from both ruling and opposition party members. Like most other central banks, the BOJ typically does not comment on political issues, but political instability could complicate policy-making. The BOJ must closely monitor the impact of fiscal policies, such as cash handouts or tax cuts promised by various parties before the election, on inflation and bond yields.

The BOJ Governor Haruhiko Kuroda will hold a monetary policy press conference at 14:30 Beijing time on Thursday to provide detailed explanations of the interest rate decision and economic outlook.