The Bank of Japan may raise interest rates in December, repeating the first three tightening measures within a year since the bubble burst

According to Zhitong Finance APP, Bank of Japan Governor Kazuo Ueda is carefully weighing various data at a critical moment before the policy decision on December 19, intending to make a wise choice at the last minute. He will focus on the upcoming Bank of Japan Tankan survey (December 13) and the Federal Reserve's interest rate decision before the Bank of Japan sets its policy. If the economy meets expectations, Ueda may choose to raise interest rates in December, marking the first time the Bank of Japan has tightened policy three times in a year since the peak of Japan's asset bubble in 1989, with the policy rate expected to rise from 0.25% to 0.5%, reaching the highest level since 2008.

Figure 1

In an interview, Ueda reiterated the possibility of an interest rate hike and noted that the timing is "approaching," as inflation persists, corporate investment plans are clear, wages are rising, and the annual wage negotiations have started optimistically, indicating that the economy is transitioning to a positive wage-price cycle. These economic signals have heightened the urgency for a rate hike, leading most economists to anticipate that the timing of the rate increase, originally expected in January next year, may be moved up to December. Ueda's statements have also driven changes in market expectations, causing the yield on two-year government bonds to rise to a new high since 2008.

"The next rate hike is very likely to come in December," said Ko Nakayama, chief economist at Okasan Securities and former Bank of Japan official. "The Bank of Japan has indicated that if the economic trajectory aligns with official forecasts, a rate hike will follow, and more and more evidence currently supports this expectation."

The last time the Bank of Japan raised rates three times in a year was back in 1989. The last rate hike that year coincided with Christmas, and just four days later, the Nikkei 225 index reached its historical peak of 38,957.44 points. This series of rate hikes raised the official bank rate from 2.5% at the beginning of the year to 4.25%, and combined with the Bank of Japan's warnings about economic bubbles, it placed heavy pressure on the economy and weakened investors' overly inflated confidence. It wasn't until February of this year, 35 years later, that the stock market finally returned to this historical high.

However, the economic environment that Ueda faces is vastly different from that of 1989. Today, Japan is an aging economy struggling to rebuild the cycle of inflation, economic vitality, and growth. Ueda hopes the central bank can return to orthodox interest rate control policies and ended its large-scale monetary easing program in March this year, achieving the first rate hike in 17 years, laying an important foundation for the policy direction in 2024.

The next rate hike will push the Bank of Japan's policy rate from 0.25% to 0.5%, reaching the highest point since 2008. Although this interest rate level remains relatively low compared to the borrowing costs of major central banks globally, this adjustment undoubtedly marks a significant shift in monetary policy compared to the previously implemented negative interest rate policy, which was maintained at -0.1% for a long time Despite the unexpectedly rapid progress in the policy adjustments by Kazuo Ueda, there have been obstacles such as market turbulence. The second rate hike in July triggered a market crash, but it eventually stabilized. Ueda vowed to communicate cautiously before the central bank takes the next step, avoiding direct hints at interest rate actions like the Federal Reserve. He chose to use the term "near," which suggests the possibility of action while maintaining flexibility.

In addition, the governor emphasized that he is closely monitoring the progress of wage negotiations and the risks that the U.S. economy may face, especially during the current political transition period, as authorities strive for a smooth economic landing. He mentioned that the strong wage growth in the spring of this year was a key factor driving the bank to begin tapering stimulus measures in March.

Figure 2

As the decision day approaches, the interest rate gap between the U.S. and Japan may narrow, and both sides may take action. Traders have raised their expectations for both a Federal Reserve rate cut and a Bank of Japan rate hike, estimating the likelihood of a Fed rate cut at about 67% and a BoJ rate hike at about 61%.

"If the Federal Reserve takes action while the Bank of Japan remains inactive, it may reveal the BoJ's cautious stance and lead to a depreciation of the yen," Nakayama stated. "Moreover, this situation could trigger market turmoil, thereby threatening the stability of financial markets."

Some economists believe that political factors may delay the Bank of Japan's rate hike decision until January next year, as Prime Minister Shigeru Ishiba's position has become precarious after the ruling coalition lost its parliamentary majority and suffered the worst electoral defeat since 2009 in October, necessitating cooperation with the opposition to pass additional budgets and make legal amendments.

Economists Ryutaro Kono and Hiroshi Shiraishi from BNP Paribas noted in a report: "Ishiba is like walking on a tightrope, as his ruling coalition lacks a majority in parliament." "If Ishiba's government cannot communicate effectively, the Bank of Japan may choose to wait and deal with other urgent matters."

However, experts who have long observed the Bank of Japan believe that since Ueda accepted the interview request, it may suggest he is open to a rate hike in December. He only gives two media interviews a year, so the timing of last weekend's interview may be significant.

Naomi Muguruma, chief fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities, wrote in a report: "If the Bank of Japan is indeed considering a rate hike in January, there would be no need to accept an interview and signal a rate hike now. The BoJ's move may be preparing for further rate hikes at the December meeting."