In October, the decision to "hold steady" has become a certainty. How will the Bank of Japan set the tone for interest rate hikes in the face of uncertainties surrounding the elections in Japan and the United States?

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2024.10.30 10:20
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Investors are particularly focused on whether Bank of Japan Governor Kazuo Ueda will signal the timing of the next interest rate hike; Citigroup believes that the impact of the Japanese election on the central bank mainly comes from the fiscal side. If Shigeru Ishiba successfully forms a coalition government with the small parties, it may expand the fiscal stimulus plan; meanwhile, the impact of the U.S. election is reflected in the yen exchange rate. If the Republican "red wave" accelerates the depreciation of the yen, it may force the Bank of Japan to raise interest rates in December

The Bank of Japan's monetary policy meeting in October will officially announce its decision on Thursday. The market almost unanimously expects a "hold" stance, with investors focusing on whether Governor Kazuo Ueda will signal the timing of the next interest rate hike during the press conference. The inflation forecast for the fiscal year 2024 and potential fiscal policy shifts after the Japanese elections are also key points of interest.

Regarding the timing of the next interest rate hike, there is some divergence in the market. A Bloomberg survey shows that about 87% of Bank of Japan watchers expect the central bank to raise rates before the end of January, with 53% expecting a hike in December. Compared to the September survey, the number of those expecting a rate hike in January next year is increasing.

However, there are still variables. Citigroup analysts believe that if the "red tide" of the U.S. elections accelerates the depreciation of the yen, it may force the Bank of Japan to raise rates in December.

It is worth noting whether Governor Kazuo Ueda will reaffirm the central bank's current stance during the press conference: if Ueda reaffirms that the inflation outlook will be realized, this may indicate that the Bank of Japan will continue to raise rates; if Ueda states that he has time to consider the next policy measures, this suggests that policy changes will not happen quickly.

Two Elections Disturb, U.S. Greater than Japan

The Bank of Japan currently faces a very uncertain political environment (U.S.-Japan elections). Before this meeting, the ruling Liberal Democratic Party (LDP) in Japan just suffered its biggest defeat in 15 years in the parliamentary elections, losing its majority and needing to seek a third party to continue governing. The results of next week's U.S. elections also create uncertainty for the future trajectory of the yen.

In a research report on October 25, Citigroup stated that the impact of the Japanese elections on the central bank mainly comes from the fiscal side, while the impact of the U.S. elections is primarily reflected in the yen exchange rate.

Regarding the Japanese elections, the previously ruling coalition (LDP and Komeito) still has the possibility of forming an alliance with minority parties such as the Japan Innovation Party or the Democratic Party for the People (DPFP) to continue governing. The DPFP and the Japan Innovation Party currently advocate for cuts in consumption tax and gasoline tax. If Shigeru Ishiba fails to gain support from the opposition and the anti-Ishiba faction within the LDP abstains, a minority government led by the Constitutional Democratic Party may form.

LDP leader Shigeru Ishiba has stated that there will be a larger economic stimulus plan than last year. Given the upcoming 2025 Senate elections, the scale of this plan may increase to stabilize the political situation.

However, if Ishiba fails to gain support from the opposition and the anti-Ishiba faction within the LDP abstains, a minority government led by former Prime Minister Yoshihiko Noda may form. The new government may raise progressive income tax and financial income tax, as well as increase corporate tax rates, which could negatively impact the stock market.

UBS stated in a research report on October 28 that the view of some commentators that "political uncertainty makes it difficult for the Bank of Japan to quickly raise policy rates" may not hold true. Once the new government is established (to be completed within a month), political instability will be resolved, and the Bank of Japan may still have the possibility of raising rates in December In terms of the U.S. election, the market is currently pricing in a significant victory for the Republican Party. Citigroup believes that if the "red wave" accelerates the depreciation of the yen, it may force the Bank of Japan to raise interest rates in December.

Will the press conference be more "hawkish"?

Citigroup believes that if the Federal Reserve further cuts interest rates in the future, the narrowing of interest rate differentials may put downward pressure on the yen. Given the recent weakness of the yen (reaching the critical level of 150), Kazuo Ueda's press conference may appear slightly hawkish to stabilize the yen.

At the previous IMF annual meeting, Kazuo Ueda publicly stated that in a highly uncertain environment, he hopes to gradually raise interest rates, but this may lead to expectations that rates will remain low for a long time, which could result in the accumulation of speculative positions, making it necessary to strike a balance between the two.

Citigroup stated that it is clearly "unwise" to specify the timing of interest rate hikes before the Federal Reserve cuts rates and the results of the U.S. election are announced. The Bank of Japan is well aware that shifting to a more urgent timetable may prompt financial markets to price in expectations of rate hikes in December or January. However, if it is as "dovish" as in September, it may reignite the upward risk of import inflation, making a more ambiguous "hawkish" stance a wiser choice.

Bank of America stated in its research report on October 28 that the Bank of Japan wants to avoid sounding too relaxed about future rate hikes, and Kazuo Ueda will emphasize the positive developments in domestic data, aiming to maintain expectations for rate hikes in December/January while retaining some flexibility in the timing of actions.

Will prices rise in FY2024?

Regarding the outlook report for October, whether the Bank of Japan will remove the upward price risk for FY2024 (ending March 2025) is also a major point of interest.

A Bloomberg survey shows that about 45% of economists believe the central bank will stick to this risk assessment, while 41% expect the central bank to make changes, and another 14% find it difficult to judge.

Morgan Stanley noted in its latest report on October 23 that if the Bank of Japan removes the upward price risk for FY2024 in the October outlook report, market expectations for a rate hike in December may weaken.

Additionally, Kazuo Ueda mentioned in a speech on September 24 that during the rate hike in July, consideration was given to the renewed rise in import prices due to the depreciation of the yen, which constituted an upward price risk.

However, he also pointed out that since August, the one-sided depreciation of the yen has eased, and the rise in import prices has slowed, with September's import prices falling 2.6% year-on-year, marking the first decline in eight months. But in recent weeks, the yen's exchange rate has weakened again, with the dollar-yen rate breaking through the 150 mark, and these fluctuations and their impact on prices may complicate the Bank of Japan's viewpoint.

Morgan Stanley believes that the Bank of Japan may maintain its view on the upward price risks for FY2024 and FY2025. Bank of Japan Executive Director Takeshi Kato stated on October 22 that in an environment of continued yen depreciation, prices may be more significantly affected