Bank of Japan shifts to “anti-inflation” mode! Kazuo Ueda hints at further room for rate hikes, December move under watch

According to Zhitong Finance APP, the Bank of Japan maintained its policy interest rate at 1.25% on Friday, but remarks from Governor Kazuo Ueda at the subsequent press conference sent policy signals more noteworthy than the rate decision itself. As underlying inflation has reached a level broadly consistent with the 2% target, the BOJ’s policy focus is shifting from driving price increases to preventing inflation from deviating from the target. Ueda made it clear that the BOJ will not passively wait for inflation expectations to naturally anchor; rather, it will adjust policy in a timely manner according to economic, price, and financial conditions. In other words, the phase of the BOJ chasing the 2% inflation target is nearing its end, and a new stage of monetary policy normalization is underway.

The most intriguing aspect of Ueda's remarks was his explanation of the boundary between "target already achieved" and "target not yet achieved."

He stated that Japan’s underlying inflation has reached a level consistent with the price target, but the BOJ aims for a sustainable and stable realization of the 2% inflation target. “In this sense, we have not yet achieved the target.” This does not mean the central bank will continue to wait passively; rather, appropriate monetary policy adjustments are required to ensure that underlying inflation is stably anchored around 2%.

This statement reflects a change in the BOJ’s policy response function. Previously, the central bank was long concerned about insufficient inflation, focusing on escaping deflation and driving sustained price increases. Now, with underlying inflation approaching the target, the BOJ is placing more emphasis on whether inflation expectations can stably anchor around 2% and on whether rising energy and raw material costs will further push up prices.

Ueda specifically pointed out that Japan’s inflation expectations are not yet fully anchored near the target. The BOJ will continue to monitor multiple indicators, but more importantly, it will assess the mechanisms behind price changes, especially whether medium- and long-term inflation expectations are already stable near the target. He also stressed that once underlying inflation reaches 2%, it is undesirable for prices to overshoot the target significantly, so the BOJ must appropriately address upside risks.

The hawkish tone here is that the BOJ no longer needs to see inflation rise further before considering tightening policy. As long as underlying inflation is close to target, financial conditions remain loose, and upside risks persist, there is a stronger case for further rate hikes.

"No Waiting": Pace of Hikes Depends on Data and Cumulative Effects

As for the next policy steps, Ueda did not provide a clear timetable for further rate hikes, nor did he give markets a reason to sit by and wait.

He said that the pace of future rate hikes will largely depend on upcoming data, and the BOJ cannot predetermine the number of months between each hike. The bank will comprehensively assess at each policy meeting the probability of achieving baseline economic and price outlooks, as well as the associated risks.

This means the BOJ does not intend to mechanically raise rates according to a set timetable, but it does not rule out taking action every few months. Ueda emphasized that the central bank must simultaneously assess both the risk of underlying inflation overshooting and the current degree of monetary looseness.

Regarding the market’s focus on the neutral rate, Ueda admitted that it is not easy to determine when the policy rate will reach neutral. The BOJ needs to consider the cumulative impact of past hikes, as current financial conditions may not fully reflect the total effects of previous rate adjustments. He indicated that the BOJ still needs to narrow the gap between the policy rate and the neutral rate by gradually adjusting its degree of monetary easing.

This also explains why the BOJ did not continue hiking at this meeting. The central bank wants to further observe the cumulative impact of previous hikes on lending conditions, economic activity, and prices, rather than take immediate action merely because underlying inflation has reached 2%.

This meeting ended with an 8-1 vote to keep rates unchanged. Hawkish member Hajime Takata objected, advocating for a hike of the policy rate to 1.5%. This division also indicates that calls for accelerating policy normalization are emerging within the decision-making body.

Energy Costs Transmitted to Consumers; Wage Negotiations Remain Key Variable

Ueda’s assessment of rising inflation risks also leaves room for future rate hikes.

He noted that conflict in the Middle East has pushed up energy and raw material costs, pressures that have already been clearly reflected in inter-company prices. Data from September and October now show these upward pressures spreading further into consumer prices. As cost pressures are passed on to consumers, underlying inflation may also be driven higher.

However, what the BOJ needs to assess is not just the short-term price spike from rising energy costs, but also whether these price changes can foster a more enduring inflation mechanism through wages, service prices, and inflation expectations.

In Ueda’s view, to stably anchor underlying inflation at 2%, wage negotiations between companies and unions must be based on the premise that inflation will operate near 2% in the future. He noted that this year’s average consumer inflation may be around 2% or slightly lower, and the BOJ needs to observe how this will impact next year’s spring wage negotiations.

Whether wage growth is sustainable is a crucial factor for the central bank in judging whether inflation truly has endogenous momentum. If companies continue to raise wages and pass labor costs on to goods and service prices, Japan could establish a more stable wage-price cycle. Conversely, if price increases are mainly driven by energy and import costs, the sustainability of inflation remains uncertain.

The BOJ’s quarterly outlook report released on Friday also reflected heightened concern about price risks. The central bank raised its core CPI growth forecast for the fiscal year ending March 2028 from 2.4% previously to 2.6%, and noted that long-term inflation expectations are fluctuating around 2%. The report also stated that Japan’s economy is expected to grow moderately, but the situation in the Middle East and rising energy costs remain uncertainties.

December Rate Hike Expectations Rise; Japan Bond Market Seeks New Pricing Anchor

Ueda’s remarks have further reinforced market expectations for another BOJ rate hike this year. According to a prior Reuters survey of economists, among those anticipating a hike in Q4, about 80% believe it could happen in December. Institutions such as Citi and MUFG also point to the next possible rate hike occurring in December or January next year.

However, market expectations for rates at the short end and yields on long-term Japan government bonds (JGBs) do not always follow the same logic. The short end more directly reflects market expectations for the BOJ’s next rate move; the long end is influenced by the expected future rate path, inflation expectations, sovereign bond supply, and term premia, among other factors.

Japan’s 30-year government bond yield rose in October to a historical high near 4.25% before retreating. As of October 30, it had fallen back to about 3.84%. The retreat in long-term yields reflects changing market pricing for Japanese government bonds, but it does not mean investors are no longer concerned about further BOJ hikes.

In fact, some global asset managers have recently started to selectively increase their holdings of Japanese government bonds. According to Bloomberg, Allianz Global Investors is selectively adding to mid- and long-term JGBs, BNP Paribas Asset Management has raised its positions in 20- and 30-year bonds from "very small" at the start of the year to "medium size," and T. Rowe Price also now prefers longer-dated Japanese bonds.

BNP Paribas Asset Management’s flexible strategies include going long 20- and 30-year JGBs while shorting 2- and 5-year JGBs, betting on a flatter yield curve. Such trades are not betting on the BOJ stopping rate hikes; rather, they expect the short end to remain responsive to policy normalization, while the long end could benefit from demand created by previously high yields and the market’s reassessment of the future rate path.

Therefore, the core issue in the Japanese government bond market is shifting from “When will the BOJ hike again?” to “Where will rate normalization ultimately end?” If investors gradually form an opinion on the endpoint of monetary tightening, long-term yields may not necessarily rise in tandem every time expectations for short-term hikes intensify.

From Rate Normalization to Balance Sheet Adjustments: BOJ Further Exits the Era of Easing

Besides Ueda’s remarks, the BOJ also announced on Friday an acceleration in selling its holdings of exchange-traded funds (ETFs). Starting January 2027, the bank will increase its annual ETF sales from about 330 billion yen to about 860 billion yen (at book value).

At this new pace, the BOJ expects it will take about 43 years to fully dispose of its ETF holdings—a substantial reduction from the prior estimate of 112 years. While the process remains lengthy, the increased sale scale means the central bank is accelerating the reduction of assets accumulated during past periods of massive monetary easing.

This decision is in line with changes in rate policy: The BOJ needs not only to gradually raise the policy rate but also to slowly exit long-running unconventional easing measures. However, the actual market impact of ETF sales will depend on selling pace, market liquidity, and investor capacity to absorb sales, so it should not be interpreted as a short-term large-scale selloff shock.

For the yen, the BOJ’s increased emphasis on upside inflation risk and its openness to further rate hikes could, in theory, help limit widening Japan-U.S. rate differentials and provide some support for the yen. However, the direction of the yen will still depend on the Fed’s policy path and changes in U.S. Treasury yields. The BOJ’s hawkish stance alone is not enough to signal a sustained appreciation cycle for the yen.

For the global bond market, changes in Japanese long-term yields are likewise noteworthy. An increase in JGB yields could make domestic assets more attractive to local institutions, potentially affecting Japanese investors’ willingness to allocate to U.S. Treasuries, European debt, and other foreign assets. However, actual capital flows depend on factors such as FX hedging costs, overseas bond yields, and institutional liabilities—the outcome cannot be inferred from a single BOJ policy meeting.

Overall, the BOJ’s decision on Friday to keep rates unchanged does not indicate a cautious or dovish shift in policy stance. The real message from Kazuo Ueda’s remarks is that now that underlying inflation has reached a level consistent with the 2% target, the central bank’s focus must shift from pushing inflation up to preventing overshooting. The BOJ still needs to monitor wage growth, inflation expectations, and the cumulative effects of previous hikes, but the direction towards further tightening is already quite clear.

For markets, the next rate hike may come in December, but more important than the precise timing is that the BOJ is gradually clarifying the objectives and boundaries of monetary policy normalization. Japanese bonds, the yen, and global capital allocation will all be repriced under this new policy framework.