Fiscal expansion is reshaping the trajectory of Japan's monetary policy.
JPMorgan released a report on August 7 stating that the Japanese government's push for tax cuts and expanded fiscal support will further increase pressure on the Bank of Japan (BOJ) to tighten monetary policy. Against the backdrop of fiscal stimulus potentially boosting economic demand and exacerbating inflation risks, the bank believes the BOJ's pace of rate hikes may accelerate.
While the probability of a September rate hike has notably risen recently, JPMorgan maintains its baseline forecast for an October rate hike. It has also revised its forecast for 2027, increasing the expected number of rate hikes from two to three, and projects the BOJ's policy rate will reach 2% by the end of 2027.
Simultaneously, JPMorgan warns that Japanese Prime Minister Shigeru Ishiba's push for a reduction in the consumption tax on food carries clear electoral motives. The persistent domestic political pressure to slow the pace of rate hikes could cause the BOJ to continue lagging behind the inflation curve. If monetary policy remains accommodative for too long, a future "catch-up" tightening cycle to curb inflation could push the terminal policy rate above the current forecast of 2%.
September or October? JPMorgan Still Bets on October
After the BOJ recently signaled a possible rate hike as early as September, the market quickly raised expectations for action at that meeting.
JPMorgan acknowledges that the risk of a September rate hike has increased significantly but maintains an October rate hike as its base case scenario.
The reason is that if the BOJ were to hike in September, following its move in June, the market would quickly price in a further hike in December. This would force the central bank to abandon its repeatedly emphasized "gradualist" policy pace, which policymakers are keen to avoid.
JPMorgan believes that U.S. economic data over the coming weeks, the dollar's trajectory, and their impact on the yen exchange rate will be key variables determining whether the BOJ ultimately chooses to act in September or October.
2027 Rate Hike Forecast Revised Upward to Three
A more significant change lies in the medium-to-long-term policy path.
JPMorgan has revised its forecast for 2027 rate hikes from two (April and October) to three (March, July, and December), projecting the policy rate will reach 2% by the end of 2027.
The report argues that with Japan's plan to reduce the consumption tax on food from 8% to 1% for two years starting April 2027, and with the funding source for the tax cuts still undecided, the BOJ will be forced to accelerate its policy normalization pace. This is against the backdrop of continued fiscal expansion, persistent global inflationary pressures, and ongoing yen depreciation risks, all to prevent inflation expectations from becoming further unanchored.
In other words, the looser the fiscal policy, the greater the pressure for monetary tightening.
For the market, this means that the interaction between Japanese interest rates, the yen exchange rate, and fiscal policy will remain a core variable influencing the performance of Japanese assets in the coming months.
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