Daiwa forecasts December BOJ rate increase after Ueda's policy pivot

According to Daiwa, a rate increase in December aligns with a consistent quarterly schedule, which ought to reduce market surprises, though the firm sees the balance of risks leaning toward sooner action. This outlook sustains upward pressure on the short end of the Japanese government bond curve, as the 10-year yield has already reached levels not seen since 1996.

The yen plays a pivotal role. Daiwa notes that a significant depreciation in the yen is among the few factors that could accelerate BOJ action, so yen weakness could cause rate hike expectations to move sooner. For AUD/JPY, both the RBA and BOJ are tightening, which diminishes the rate differential trade that has historically buoyed the pair.

If the BOJ revises its inflation projections upward in the October Outlook Report, that would serve as the initial test for the December rate hike prediction.

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The central bank's task has shifted from raising inflation to 2% to maintaining it at that level. Daiwa interprets Ueda's "new phase" comments as signaling quarterly increases, beginning in December, with the balance of risks pointing toward earlier action.

The key takeaways from Daiwa are:

• According to Daiwa, the next BOJ rate increase will occur in December 2026, with a subsequent hike in April 2027, and the terminal rate is expected near 2%.
• The BOJ increased its policy rate to 1.25% in September, and Ueda announced a change in the policy regime.
• The current objective is to hold underlying inflation steady at 2% and avoid an overshoot, with equal consideration given to both upside and downside risks.
• Concerns are being driven by rising oil prices, robust wage growth, elevated inflation expectations, and firms' increased willingness to pass on costs.
• Ueda did not exclude the possibility of consecutive rate increases or a 50-basis-point move, but Daiwa regards quarterly increments as the more probable path.
• If oil prices remain elevated, the BOJ may raise its inflation forecasts in the October Outlook Report.

Economist Kenji Yamamoto of Daiwa Securities predicts the Bank of Japan will raise rates again in December, with another increase in April 2027. He contends that the September rate move represented a true inflection point in policy conduct. The BOJ raised its policy rate to 1.25% this month, and Yamamoto anticipates further tightening at approximately one hike per quarter, with a terminal rate near 2%.

According to Yamamoto, the crucial change lies in the BOJ's goal. During his press conference following the meeting, Governor Kazuo Ueda stated that the policy phase had shifted. Since underlying inflation is now near 2%, the objective is no longer to move inflation toward the target but to maintain it there and avoid exceeding it. Yamamoto observes that this message was well communicated, as it had been foreshadowed in the July Summary of Opinions and in a speech by Deputy Governor Ryozo Himino just prior to the meeting.

This shift is significant because the BOJ will now consider both upside and downside risks to inflation symmetrically. Previously, upward price pressure was welcomed as it helped inflation reach 2%. Now, such pressure threatens to keep inflation persistently above target, especially as Japanese firms have grown much more inclined to pass on higher costs to consumers. Ueda cited four factors behind the September rate increase: deterioration in the Middle East situation, AI-related demand exceeding expectations, high inflation expectations, and solid wage data.

Oil remains a key worry. Ueda noted that a second wave of energy-led price rises is arriving before the first wave has completely passed through to consumer prices. If crude oil prices remain elevated, Yamamoto believes there is an increasing likelihood that the BOJ will lift its core inflation forecasts for this fiscal year and the next in the October Outlook Report.

Ueda indicated that the next policy move would essentially be a rate increase, and he did not dismiss the possibility of consecutive hikes or a 50-basis-point increment should the risk of inflation substantially exceeding the target intensify. Nevertheless, Yamamoto views back-to-back hikes as improbable. Financial conditions have already tightened significantly via long-term and super-long bond yields, despite bank lending and asset markets still being accommodative, and the neutral rate level remains unclear.

A quicker pace of tightening would necessitate a further accumulation of inflation risks or a sharp yen depreciation that boosts import costs. Conversely, if previous rate increases start to noticeably constrain lending and asset markets, the pace would probably decelerate. Yamamoto currently sees no reason to revise his 2% terminal rate forecast upward, but he assesses that risks are skewed toward earlier hikes and a marginally higher rate path. Ueda offered no indication of where the peak might be and did not imply that 1.25% is the neutral rate.

During the September meeting, the BOJ also tightened a facility that supports climate-related lending. It converted the loans to a floating rate and placed a cap on them, so that the program no longer offsets the impact of rate increases. Yamamoto views this as a minor adjustment but additional proof that normalization now extends beyond just the policy rate.