The Bank of Japan will likely stand pat next week. We do not expect Governor Ueda to provide any new insight about specific timing of a next rate hike, although the BoJ will continue to argue for a resumption of policy normalization. We assume that the BoJ’s primary objective at the September meeting is to maximize its optionality in terms of the timing of policy moves, given the massive uncertainty concerning Japanese politics and the Fed easing. Local politics overshadow efficient monetary decision making currently in Japan. LDP is likely to elect a new leader via a full ballot of the party membership to be held on October 4. We believe amongst two chief contenders, Koizumi is more likely to win than Takaichi. Senior leaders including Aso, Kishida, and Suga want to stop Takaichi from becoming the new party president. Ishiba’s departure was engineered by an unofficial alliance of Aso, Kishida and Suga. Their common interest is to prevent Takaichi from becoming Ishiba’s successor. Whoever becomes prime minister, the coalition’s minority position means a fiscal expansion is all but certain. The key question is whether the coming fiscal expansion will be accompanied by political pressure on the BoJ to slow—or abandon—its program of monetary tightening. There are good reasons to believe the incoming premier will find it expedient to maintain the show of BoJ independence. First and foremost being Japan relationship with US. US Treasury secretary Scott Bessent recently rebuking the BoJ for failing to raise interest rates more rapidly, even though Japanese inflation is running hot by recent historical standards. Having agreed relatively favourable tariff rates with the US, Japanese policymakers will not want to risk fresh tariff increases in retaliation for their perceived deliberate undervaluation of the yen via an excessively loose monetary policy. 2nd being rising food prices especially rice prices won't allow any future PM to lean against BOJ hikes. Hence the recent dynamics in Japanese financial markets—a steepening yield curve, rising equity prices and a gradually strengthening yen—are likely to remain in place, no matter who arrives in office as Japan’s next prime minister. The key focus of next week's meeting will be the presence or absence of a rate hike proposal. Since the enactment of the new Bank of Japan Law in 1998, there have been three instances (July 2000, January 2007, and December 2024) where a rate hike proposed by some Policy Board members was rejected, but in all those cases, a rate hike was decided at the subsequent MPM. If a rate hike is proposed, it will likely heighten the momentum for a rate hike within the BoJ towards October which is our view too. If it were not for domestic political uncertainties, an October hike was a done deal instead of current market pricing of only 30% probability. Massive and consecutive downward revisions in the US labor data and consequent changes in future pricing of Fed easing have also not changed the Dollar/Yen FX rate that much. Thus, the odds of Japanese auto sector being squeezed both by 15% tariff and a skyrocketing Yen appear to be quite low, at least for now. Hence the possibility of an Oct hike wont impact Japan’s exports significantly via the fx channel. The BoJ provides a uselessly wide range of estimates of neutral rate somewhere between -1% to 0.5% on a real basis. A mechanical translation implies the nominal neutral rates are somewhere between 1% and 2.5%, assuming 2% annual inflation. Hence, we believe that an October hike is very much probable. We continue to believe in JPY testing 140 odd levels by Dec’25.
