BOJ Preview: Global Market Implications

SPEAKER_1 (0:08)

Welcome to JPMorgan's At Any Rate podcast series. In this episode, we'll be conducting a preview on the Bank of Japan and what its current implications are for the global market at large.

Now, for your host and head of content strategy here at JPMorgan, Samantha Azzarello.

Samantha Azzarello (0:28)

Welcome everyone to our Bank of Japan preview call. My name is Sam Azzarello and I lead content strategy for global research.

I'm thrilled to be joined by three experts on the Japanese markets. Joining us today, we have Ayako Fujita, who's our Chief Japan Economist. We also have Junya Tanase, Chief Japan FX Strategist, and Takafumi Yamawaki, Head of Japan Fixed Income Research. They are bringing a lot of breadth and depth of expertise around this market. There's a lot going on. Global investors have been very focused on Japan, the yen. So we have a lot to get into.

So to start, we're going to kick it off with Ayako. And I want to ask what the expectations are for the September meeting and where you ultimately see policy rates in Japan peaking. Ayako.

Ayako Fujita (1:17)

Thank you, Samantha. So BOJ is highly likely delivering another 20 basis point late hike, taking the policy rate to 1.25 percent. So the key backdrop is that the BOJ has faced growing pressure to reduce its policy lag, particularly as the debate around the yen weakness has become more resilient since late July. At the same time, the political backdrop looks a bit less confrontational than in earlier episodes. There has been less overall pressure from the administration against higher rate, which lowers the huddle for the BOJ to move. So where the market focus really is, so it's not just the rate hike itself, but the messaging around the pace. If BOJ follows June was another hike now, it's left looking like a shift away from the previously emphasized cautious and gradual normalization approach. So the governor's press conference matters, maybe. Investors will be listening for whether the BOJ implicitly validates a faster pace, something like quarterly hikes, or whether it reasserts a more step-by-step approach. So on the question of where the policy rates ultimately peak, we do not expect the BOJ to offer a clear turn-down wave stigma. The BOJ has leaned on the concept of a neutral rate to anchor expectations, but it has also been emphasizing uncertainty around whether neutral actually is. And more recently, it has also highlighted the need to address upside inflation rates, which naturally raises the question of whether it might go beyond neutral into restrictive territory.

So, that said, our view is that it's still too early for the BOJ to creatively signal a move into restrictive territory, given its long-standing caution and the broader political sensitivity around the higher borrowing costs. So, in practical terms, we think the BOJ is likely to frame the destination as toward neutral while keeping the terminal rate deliberately unbeginned and data dependent, less than committing to a level.

So, we expect the BOJ's policy rate to 2.25 percent by the end of 2027

But we have argued that this level may not necessarily represent the terminal rate with the possibility that late hacks could continue into 2028

Samantha Azzarello (3:43)

Okay, excellent. That was really good level setting, Ayako. Thank you.

Let's now go deeper into some of the factors, because I don't think any central bank around the globe has it particularly easy in terms of how to make their policy decisions. But when I look at your research that you and the rest of the team have put out, there's a lot of different factors interacting with the rates outlook, which Ayako, you already mentioned a few of them, but just to go over them, we've got inflation higher than expected, or perhaps finally really heating up. There's the level of the yen. We can bring in Junya later, about the Treasury Secretary kind of commenting on the level of the yen versus the dollar. There's fiscal concerns, and then there's obviously growth, and keeping the economy humming, and growing, and expanding. Can you walk us through the high-level trade-offs and interactions that the BOJ, and by extension, investors might be watching closely?

Ayako Fujita (4:37)

Sure. High-level investors are watching a set of trade-offs that all connect back to one central question. How quickly can BOJ normalize policy without creating unwanted volatility in the economy and the market? So let me break into four interacting channels. The first one is inflation versus growth. The BOJ is increasingly highlighting upside inflation rates, which strengthens the case for continuing normalization. But Japan's growth sensitivity to financial condition is too unknown, even after decades-long low interest rate environment.

So the BOJ has to balance the risk of moving too slowly, allowing inflation risk to build, against moving too quickly and tightening into a sharp growth road and creating financial market stress. So this is one reason the BOJ will likely to keep emphasizing data dependence rather than present hiking paths. And the second trade-off is the Yen and Leipz differential. Yen is not an explicit BOJ target, but it's an important transmission channel. So at large, Japan US trade-leipz differential can keep depreciation pressure on the Yen, which can feed into import cost and inflation dynamics. So when the Yen weakness becomes politically and economically turbulent, it increases the pressure on the BOJ to reduce policy divergence. That's part of why recent moves toward collecting Yen weakness have martyrs for market expectation into this meeting.