Japan's September core inflation forecast at 2.1%, above BoJ 2% target

The USD/JPY pair has traded in a narrow band this month, fluctuating between just under 157 and just below 159, while the 200-day exponential moving average sits just above 157.50. A stronger-than-expected CPI reading could test the lower boundary, whereas a weak one might send the pair back toward 159, where the threat of intervention becomes the yen's primary support. Within Japanese government bonds, the two-year and five-year maturities are most sensitive to shifts in December rate hike expectations, with the five-year yield currently around 2.3%. For the Nikkei, a firmer yen and higher rate expectations typically weigh on exporters and benefit banks, but AI-related capital flows are expected to have a bigger impact than the CPI print unless it delivers a major surprise. Oil is the wildcard: persistent crude price strength from the Middle East conflict continues to channel energy costs into Japanese inflation and into the Bank of Japan's future projections.

---
Japan's core inflation is expected to exceed the BoJ's 2% target once more, undermining the argument for patience and bolstering the case for a rate increase in December.

Key points:

• Japan's national September CPI will be released at 2330 GMT on Thursday (7:30pm US Eastern), with core inflation (excluding fresh food) forecast at 2.1%, compared to 1.7% in August.
• Headline inflation is expected to come in at around 2.1%, up from 1.9%, while the measure excluding both fresh food and energy is seen at around 2.3%, also up from 1.9%.
• Tokyo's September figures significantly exceeded expectations, with core inflation at 2.7% and the ex food and energy gauge at 3.0%, indicating upside risk to the national data.
• The Bank of Japan raised its policy rate to 1.25% in September on a 7-2 vote and is expected to keep rates unchanged at its October 29-30 meeting, with December viewed as the next probable opportunity for a move.
• The 10-year JGB yield has declined to around 2.9% due to safe-haven flows, while USD/JPY has remained near 158.
• A September trade deficit roughly three times larger than forecasts continues to put pressure on the yen.

The September nationwide consumer price data for Japan, scheduled for release at 2330 GMT on Thursday (7:30pm US Eastern), is anticipated to reveal core inflation returning above the Bank of Japan's 2% target for the first time since December. Such an outcome would reinforce the argument for another rate increase before year-end.

According to a Reuters poll of 15 economists, core CPI (excluding fresh food but including energy) is forecast to have increased 2.1% year-on-year, accelerating from 1.7% in August. The anticipated acceleration is largely attributed to higher energy costs from the Middle East conflict being passed through to household bills. Other analysts project headline inflation to climb to around 2.1% from 1.9%. The measure that strips out both fresh food and energy, frequently used as a gauge of underlying inflation, is expected to register around 2.3%, also up from 1.9%.

The risks lean toward a stronger-than-expected reading. Tokyo's September data, released earlier this month, substantially exceeded expectations: headline and core inflation both came in at 2.7%, while the ex food and energy measure hit 3.0%. The Tokyo figures are released roughly three weeks ahead of the national data and are commonly treated as a leading indicator. The comparison is not straightforward, however. Part of the Tokyo increase was due to the expiration of some government support measures, whereas on a national level, electricity subsidies were still keeping power prices lower in August, when they were roughly 2.4% below year-earlier levels.

The data release arrives at a delicate moment for the central bank. The BoJ raised its policy rate to 1.25% in September, marking its second hike of the year. The decision was approved on a 7-2 vote, with the two dissenting members contending that inflation remained below target. Core inflation had remained below 2% for seven straight months through August, including the period covering both rate increases. A core CPI reading at or above the consensus would erode that objection just under a week before the October 29-30 policy meeting.

BoJ officials have been increasingly highlighting upside risks to inflation. Governor Kazuo Ueda told parliament this week that underlying inflation is very near the 2% target. He pointed to robust global demand driven by artificial intelligence and a tight labour market as supporting factors. Deputy Governor Himino has cautioned against the risk of delaying action. Ueda has also characterized the bank's role as anchoring inflation at around 2%, as opposed to boosting it like during the deflation period.

Nevertheless, an October rate hike is not the baseline scenario. Sources with knowledge of the bank's thinking told Reuters that the BoJ is likely to hold rates steady this month unless the yen depreciates further, raising import costs. According to the sources, the bank is expected to raise its inflation forecast for the next fiscal year as oil prices prolong price pressures, while maintaining a focus on inflation risks, which keeps the door open for a hike as early as December. Market pricing reflects almost no probability of a move in October. Estimates of December hike probabilities differ by metric, ranging from roughly 60% to about 80%.

Japanese government bonds have gained ground ahead of the CPI release. The 10-year yield has fallen to approximately 2.9%, the lowest level since early September, after reaching a peak above 3.1% in late September. The 30-year yield has declined to near 3.9%, its lowest since early August. The rally has been supported by safe-haven demand stemming from the Middle East, fiscal concerns in France, and swings in AI-related stocks. MUFG analysts forecast the 10-year yield to trade within a range of 2.85% to 3.00% this week. A strong inflation reading would put that rally to the test.

The yen has remained range-bound. USD/JPY has traded near 158 for much of October, trapped between hopes of additional BoJ tightening and persistent structural selling of the Japanese currency. Japan's September trade deficit was approximately ¥540 billion, tripling the forecast, which reflects the yen that importers need to sell to settle their invoices. Finance Minister Katayama has not revealed a specific intervention threshold, but the risk of official yen buying has helped cap the pair's upside.

Stock markets are expected to follow technology sector leads. Earlier this month, the Nikkei briefly reclaimed the 70,000 level on revived AI enthusiasm, before a worldwide sell-off in AI and semiconductor stocks dampened sentiment.

Looking past today's data, attention shifts to next week's BoJ quarterly outlook report. In the report, the BoJ is expected to indicate that underlying inflation has roughly reached 2%, signaling its preparedness to continue raising rates. A national CPI reading that confirms the Tokyo data would back that assessment. A reading below 2% would strengthen the case of the dissenting members and leave the yen more dependent on the threat of intervention.