The Zhitong Finance App learned that the Bank of Japan kept the policy interest rate unchanged at 1.25% on Friday, but Governor Kazuo Ueda's statement at the press conference after the meeting sent a policy signal that the ratio decision itself is more worthy of attention. As potential inflation has reached a level roughly in line with the 2% target, the Bank of Japan's policy focus is shifting from driving up prices to preventing inflation from deviating from the target. Ueda made it clear that the central bank will not wait for inflation expectations to naturally anchor, but will adjust policies in due course according to economic, price, and financial conditions. In other words, the Bank of Japan is nearing its end in chasing the 2% inflation target, while normalizing monetary policy is entering a new phase.
The most interesting part of Ueda's speech was his explanation of the boundary between “the goal has been achieved” and “the goal has not been achieved.”
He said that Japan's potential inflation has reached a level consistent with the price target, but the Bank of Japan is seeking to achieve the 2% inflation target in a sustainable and stable manner. “In this sense, we have not yet reached the target.” This does not mean that central banks will continue to wait passively; instead, they need to adopt appropriate monetary policy adjustments to stabilize potential inflation at around 2%.
This statement reflects changes in the Bank of Japan's policy response function. In the past, the Bank of Japan was worried about insufficient inflation for a long time. The policy focus was on getting rid of deflation and driving prices to continue to rise; now, as potential inflation approaches the target, the central bank is beginning to pay more attention to whether inflation expectations can stabilize around 2%, and whether rising energy and raw material prices will further push up prices.
Ueda specifically pointed out that Japan's inflation expectations are actually not fully anchored near the target. The central bank will continue to observe various indicators, but what is more important is to determine the mechanism behind price changes, especially whether medium- to long-term inflation expectations have stabilized near target levels. He also stressed that after potential inflation reaches 2%, it is not advisable for prices to exceed the target by a large margin, so the central bank must respond appropriately to upward risks.
The hawkish meaning of this statement is that the Bank of Japan no longer needs to wait for inflation to rise more clearly before considering tightening its policy. As long as potential inflation is close to target, financial conditions remain relaxed, and upward risks persist, there are more compelling reasons to adjust interest rates further.
Behind the “won't sit back and wait”: the pace of interest rate hikes depends on data and cumulative effects
As for the next policy path, Ueda did not give a clear schedule for interest rate hikes, but he did not provide a reason for the market to wait with peace of mind.
He said that the pace of future interest rate hikes will largely depend on upcoming data, and the Bank of Japan cannot decide in advance that an interval of several months is required between each rate hike. At each policy meeting, the central bank will comprehensively assess the possibility of achieving the benchmark economy and price prospects, as well as related risks.
This means that the Bank of Japan does not intend to raise interest rates mechanically according to a fixed schedule, but it does not rule out taking action every few months. Ueda stressed that the central bank needs to simultaneously assess the risk of potential overinflation and how relaxed the current financial conditions are.
Regarding the neutral interest rate issue that the market is concerned about, Ueda acknowledged that it is not easy to determine when the policy interest rate will reach a neutral level. The central bank needs to examine the cumulative impact of past interest rate hikes, because the current financial situation may not fully reflect the full effects of previous interest rate adjustments. He said that the Bank of Japan still needs to close the gap between policy interest rates and neutral interest rates and gradually adjust the level of monetary easing.
This also explains why the Bank of Japan did not raise interest rates continuously at this meeting. The central bank wants to further observe the cumulative impact of previous interest rate hikes on loan conditions, economic activity, and prices, rather than take immediate action simply because potential inflation reaches 2%.
In the end of this meeting, an 8-1 vote decided to keep interest rates unchanged. Hawk member Hajime Takada opposes staying on hold and advocates raising the policy interest rate to 1.5%. This disagreement also shows that there are already voices within decision makers calling for faster policy normalization.
Energy costs are transmitted to the consumer side, and wage negotiations are still a key variable
Ueda's judgment on the risk of inflation also left room for future interest rate hikes.
He pointed out that the Middle East conflict is driving up energy and raw material costs, and the related pressure was clearly reflected in inter-company prices before, and data for September and October began to show that these upward pressures are spreading further to consumer prices. As cost pressure is transmitted to the consumer side, potential inflation may also be boosted.
However, what the Bank of Japan needs to determine is not only the short-term price shock caused by rising energy prices, but also whether these price changes can form a more durable inflation mechanism through wages, service prices, and inflation expectations.
According to Ueda, in order for potential inflation to stabilize at 2%, wage negotiations between companies and trade unions need to assume that future inflation will operate around 2%. He pointed out that the average level of consumer inflation this year may be around 2% or slightly lower, and the central bank needs to observe how this situation will affect labor negotiations next spring.
Whether wage growth can continue is an important basis for the Bank of Japan to determine whether inflation is truly endogenous. If companies continue to raise wages and transfer labor costs to the prices of goods and services, Japan is expected to form a more stable wage-price cycle; conversely, if price increases are mainly driven by energy and import costs, there is still uncertainty about the sustainability of inflation.
The quarterly outlook report released by the Bank of Japan on Friday also reflects the importance it attaches to price risks. The central bank raised the core CPI increase forecast for the fiscal year ending March 2028 from 2.4% to 2.6%, and indicated that long-term inflation expectations are fluctuating around 2%. At the same time, the report points out that Japan's economy is expected to grow moderately, but the situation in the Middle East and rising energy costs still pose uncertainty.
Expectations of interest rate hikes in December are heating up, and the Japanese bond market is looking for a new pricing anchor
Ueda's speech further strengthened the market's expectations that the Bank of Japan will raise interest rates again during the year. According to a previous Reuters survey of economists, about 80% of respondents who expect the Bank of Japan to raise interest rates in the fourth quarter of this year think the action may take place in December. Institutions such as Citibank and Mitsubishi UFJ have also indicated that the next rate hike will be in December or January next year.
However, short-term interest rate policy expectations do not exactly follow the same logic as long-term Japanese treasury bond yields. The short end directly reflects the market's judgment on the Bank of Japan's next interest rate action; the long term is also affected by factors such as future interest rate paths, inflation expectations, treasury bond supply, and term premiums.
The yield on Japan's 30-year treasury bonds once rose to a record high of about 4.25% in October, then fell back. As of October 30, the relevant yield had fallen to about 3.84%. Long-term yields have fallen from a high level, reflecting changes in the market's pricing of Japanese treasury bonds, but this does not mean that investors are no longer concerned about the Bank of Japan's interest rate hike.
In fact, some global asset managers have recently begun to re-increase their exposure to Japanese treasury bonds. Bloomberg reports that Allianz Global Investors is selectively increasing its holdings of Japanese treasury bonds in the medium to long term, while BNP Paribas Asset Management is increasing its 20-year and 30-year Japanese debt positions from “very small” to “medium” at the beginning of the year. T. Rowe Price has also switched to longer-term Japanese treasury bonds.
Among them, part of BNP Paribas's asset management flexible strategy adopted a combination of increasing 20-year and 30-year Japanese bonds and shorting 2-year and 5-year Japanese bonds, betting that the yield curve will flatten. This type of transaction is not a bet that the Bank of Japan will stop raising interest rates. Instead, it believes that short-term interest rates may still be driven by policy normalization, while the long-term end has the opportunity to benefit from allocation requirements brought about by previous high yields and the market's re-evaluation of future interest rate paths.
As a result, the core question of the Japanese treasury bond market is expanding from “when will the Bank of Japan continue to raise interest rates” to “where will the normalization of interest rates eventually go.” If investors gradually form a judgment on the end point of austerity, long-term yields may not necessarily rise at the same time as expectations of every short-term interest rate hike heats up.
From interest rate normalization to balance sheet adjustments, the Bank of Japan further withdrew from the easing era
In addition to Ueda's speech, the Bank of Japan also announced on Friday that it is speeding up the sale of its exchange-traded fund (ETF) holdings. Starting from January 2027, the scale of ETFs sold by the central bank every year will increase from about 330 billion yen to about 860 billion yen (at book value).
According to the new sales rate, the Bank of Japan is expected to take about 43 years to complete the disposal of relevant positions, which is significantly shorter than the 112 years previously estimated. Although this process will still be very long, the increase in the scale of sales means that the Bank of Japan is further adjusting the assets accumulated during the past period of large-scale monetary easing.
This decision is in line with changes in interest rate policy: the Bank of Japan not only needs to gradually raise policy interest rates, but also slowly withdraw from unconventional easing measures that have been implemented for a long time before. However, the actual impact of ETF sales on the market still needs to be combined with observations on the pace of sales, market volume, and investors' ability to bear; it is inappropriate to simply understand this as the impact of large-scale sell-off in the short term.
As far as the yen is concerned, the Bank of Japan more clearly emphasizes the risk of upward inflation and reserves room for further interest rate hikes. Theoretically, it will help limit the Japan-US spread from widening, and provide some support for the yen. However, the trend of the yen still depends on the Federal Reserve's policy path and changes in US Treasury yields. Based on the Bank of Japan's hawkish statement alone, it is not enough to judge that the yen will enter a continuous appreciation cycle.
As far as the global bond market is concerned, changes in Japan's long-term yield are also worth watching. The rise in yield on Japanese treasury bonds may increase the attractiveness of Japanese domestic assets to local institutions, which in turn affects the willingness of Japanese investors to allocate overseas assets such as US bonds and European bonds. However, the actual flow of capital also depends on exchange rate hedging costs, overseas bond yields, and institutional debt structures, and cannot be inferred from just one policy meeting of the Bank of Japan.
Overall, the Bank of Japan kept interest rates unchanged on Friday, which does not mean that its policy stance is being cautious or moving towards easing. The real message of Kazuo Ueda's speech is that when potential inflation has reached a level consistent with the 2% target, the central bank's focus must shift from driving inflation to preventing inflation from being overadjusted. The Bank of Japan still needs to observe wage growth, inflation expectations, and the cumulative impact of previous interest rate hikes, but the direction of further policy tightening is already quite clear.
As far as the market is concerned, the next rate hike may occur in December, but what is more important than the specific date of the rate hike is that the Bank of Japan is gradually clarifying the goals and boundaries of monetary policy normalization. Japanese bonds, yen, and global capital allocation will all be repriced around this new policy framework.