The Bank of Japan kept interest rates unchanged but explicitly declared a partial victory in its nearly 14-year battle against deflation, while warning of upside inflation risks, with markets widely expecting the next rate hike to land as early as December.
On Friday, the Bank of Japan announced after its monetary policy meeting that it would keep its policy rate unchanged at 1.25%. Governor Kazuo Ueda said at a subsequent press conference that underlying CPI inflation has largely aligned with the 2% price stability target and is expected to remain around that level, but the central bank will continue to raise its policy rate in a timely manner in response to changes in economic activity, prices, and financial conditions. Ueda said:
"We hope to adjust interest rates to neutral levels appropriately."
The meeting also released an unexpected move: the Bank of Japan announced it will accelerate the sale of exchange-traded funds (ETFs) starting in January next year, significantly raising the annual pace from the current 330 billion yen to 860 billion yen (approximately $5.45 billion), marking a further exit by the central bank from its ultra-loose policy framework. These developments prompted markets to reassess Japan's interest rate path, with expectations for another rate hike within the year gaining momentum.
Rates Held Steady, but the Hawkish Stance Grows Clearer
The Bank of Japan said in its meeting statement that underlying inflation has broadly reached the 2% target, and the central bank's policy focus is shifting toward anchoring inflation at that level. Ueda emphasized at the press conference:
"Financial conditions remain accommodative, various upside risks exist, and we must remain vigilant against the risk of inflation exceeding the target."
In the decision to hold rates steady, a rare internal dissent emerged. Hawkish board member Hajime Takata voted against the decision to keep rates unchanged, advocating for raising the policy rate to 1.5%, but failed to win majority support. Ueda explained that the committee needs more time to examine the transmission effects of previous rate hikes on lending conditions, as well as potential risks to the economy and prices.
Ueda also said the central bank does not intend to formally declare at any specific point in time that it has achieved its price target, because it is crucial that "inflation remains stably and sustainably around 2%." The authority to declare a formal end to deflation rests with the Japanese government.
Inflation Mechanism Has Changed, Wage Growth Becomes the Key Variable
The Bank of Japan's quarterly outlook report noted that underlying inflation has risen to a level "broadly consistent with the price target," a judgment unanimously shared by all board members. Ueda said the wage growth mechanism driving inflation has been restored, and medium- to long-term inflation expectations are stable near 2%.
However, he also noted that whether wage increases can become the norm in the future remains a core issue the central bank must continue to assess. He said the central bank will closely monitor whether medium- to long-term inflation expectations remain stable around 2%, and will track various data to determine whether trend inflation has truly stabilized. "We cannot tolerate a further rise in underlying inflation, and it is more important than ever to ensure that underlying inflation does not exceed the 2% target," Ueda said.
Ueda also said that the government's various economic stimulus measures, along with the persistently accommodative monetary environment, are expected to strongly support the economy in achieving the 2% price target.
Converging with Western Central Banks, the Rate Hike Cycle Continues
The overall shift in the Bank of Japan's policy stance is gradually converging with the orientations of the Federal Reserve and the European Central Bank — both of which face upward inflation pressure from the AI boom and energy shocks caused by the Iran conflict, and are considering further rate hikes in the near term.
Ueda said the central bank will carefully consider the timing and pace of monetary policy adjustments based on the likelihood of realizing the baseline economic outlook scenario and related risks, and will conduct in-depth analysis of economic and price conditions at each policy meeting. He stressed that the central bank's goal is to proactively guide inflation to stabilize around 2%, "rather than waiting passively."
On the ETF reduction arrangement, the Bank of Japan's announcement to accelerate the pace of sales was interpreted by the market as exceeding expectations, further confirming its directional intent to exit its loose policy framework. Combined with the hawkish board member's dissenting vote and the explicit statement that inflation has reached its target, market pricing for a December rate hike has risen somewhat.
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