Japan reaction: Focus turning back to domestic growth and inflation dynamics

As expected, the Bank of Japan (BoJ) maintained its current policy stance at this week’s meeting, unanimously voting to keep the short-term policy rate unchanged at 0.25%. Perhaps more interesting was the subtle shift in focus away from global factors. Indeed, the Bank noted that the prospect of interest rate cuts by other major central banks and easing global inflation should avert an economic slowdown in areas such as the US and European economies, which Governor Ueda had flagged as the key downside risks at the previous meeting. And at the press conference, the Governor stated that the Bank would be following standard policy, adjusting policy based on the evolution of domestic growth and price conditions, with less attention paid to global risks.

On the domestic front, the Bank seems broadly positive. Alongside the policy announcement, the Bank released its updated forecasts which continued to show the BoJ expects growth to surpass potential over the coming couple of years, further strengthening the virtuous wage/price spiral. Policymakers continued to forecast growth of 0.6% in FY24 and 1% in FY26, while revising up its forecast for FY25 to 1.1%, from 1% previously. And on the CPI front, the forecasts were consistent with underlying inflation increasing to a level in line with the 2% price target over the medium term. Indeed, the Bank upgraded its outlook for the so-called “new” core inflation rate – which excludes fresh food and energy – by 0.1 percentage point in FY24 to 2%, while leaving it unchanged in FY25 and FY26 at 1.9% and 2.1% , respectively. Note, though, that the Bank removed its description of significant upside risks to prices in fiscal 2024, given the fact that, despite some volatility, the ongoing depreciation in the yen seems to have largely abated.

Admittedly, we see downside risks to the BoJ’s growth forecasts. Yes, the announcement from Rengo of the initial wage target points to wage growth remaining elevated over the next 12 to 18 months. But uncertainties remain around the outlook for consumption and whether households will rush out to spend any additional cash from rising real incomes. Broadly, though, the picture is positive, with inflation likely to hover around the 2% target over the next couple of years. As a result, while we still think the BoJ will wait until January to push through the next 25bp hike to 0.5%, the risks of the balance tipping in favour of December have increased.

The prospect of a Trump victory in the US elections next week, meanwhile, is a key risk we see going forward. Indeed, we see a materially different path for the path for Japan’s short-term policy rate over the next couple years depending on the outlook of the US election, with the BoJ likely to hike rates more aggressively if a stronger dollar/weaker yen emerged and US rates remained higher-for-longer, easing the headwind to BoJ policy normalisation of other major central banks easing as the BoJ hikes.