With the Bank of Japan (BOJ) set to decide its benchmark rate on the 31st local time, the view is growing that it will move to raise rates again earlier than expected as a weaker yen and higher global oil prices coincide.
The Japan Central Bank (BOJ) will hold its monetary policy meeting on the 30th–31st. Last month, it raised the benchmark rate to 1% annually, the highest in about 30 years.
According to local media including Nikkei, markets see a strong chance the Bank of Japan will keep rates on hold at this meeting. However, if the yen's weakness and rising global oil prices continue, the timing of an additional hike could be brought forward.
Data from Totan Research and Totan ICAP show investors put the probability that the Bank of Japan will raise the benchmark rate to 1.25% annually by October at about 90%. That is a sharp increase in less than a month from about 60% at the end of last month.
◇ Yen at a 40-year low… high oil prices and the Honebuto guidelines fuel the slide
The main reason expectations for an early rate hike have grown is the yen's depreciation. The yen fell to 163.99 per dollar last week, its lowest since November 1986, roughly a 40-year low.
Rising tensions in the Middle East have also driven investors to buy the safe-haven dollar, pressuring the yen. The dollar index, which measures the dollar's value against major currency, rose 0.7% over the past five sessions and is moving around 101.
A weaker yen increases the burden on Japanese corporations and consumers. Japan imports a significant share of its energy resources, including crude oil and natural gas. When the yen weakens, more yen is needed to import the same amount of oil, which can feed through to higher electricity and gas bills and higher prices for various products.
Rising global oil prices are another factor pushing up prices in Japan. With instability in the Middle East continuing, on the 24th Brent crude futures topped $100 per barrel, and West Texas Intermediate (WTI) futures in the United States at one point rose above $90 per barrel.
Policy uncertainty inside Japan is also cited as a factor weakening the yen. The Takaichi administration, in the recently released basic policy for economic and fiscal management known as the "Honebuto guidelines," effectively scrapped the previous target for a single-year surplus in the primary balance and presented a plan to significantly expand fiscal spending. Honebuto means "thick bones," referring to the broad direction of economic policy the Japanese government announces each year.
The draft also included language that could be interpreted as reining in the Bank of Japan's rate hikes. Markets worried about an increase in national debt due to expansionary fiscal policy and about damage to the BOJ's independence, and selling of Japanese Government Bonds increased, sending long-term government bond yields sharply higher. Although the Japanese government added language in the final version to the effect that monetary policy would be left to the BOJ's judgment, it failed to reverse the yen's weakness.
◇ "Additional rate hike expected in October"
Markets expect the BOJ to raise rates again within months if a weaker yen and higher oil prices increase inflationary pressures. Bank of America (BofA) securities' Japan unit projected the Bank of Japan will move to raise rates again in October.
A medium- to long-term inflation expectations gauge compiled by BofA jumped in the second quarter of this year, approaching the BOJ's 2% price target. On a proprietary gauge the BOJ introduced this year, inflation expectations have already exceeded 2%.
Kudo Takayasu, a BofA Japan economist, said, "Although the government is taking a cautious stance on rate hikes, rising inflation expectations will bolster the case for the BOJ to bring forward the timing of an additional hike."
However, some analysts say that even if the BOJ raises rates, a sharp rebound in the yen may be difficult. That is because the U.S. Federal Reserve (Fed) may also raise rates due to rising prices. If U.S. rates rise as well, even a small rate increase in Japan may not be enough to prompt investment funds to shift from dollars to yen.
Kamiyama Naoki, chief strategist at Amova Asset Management, said, "If Japan raises rates aggressively, the yen could strengthen, but that is unlikely," adding, "Raising rates by 0.25 percentage point every six months is unlikely to lead to sustained yen strength."