The Bank of Japan's July monetary policy meeting is widely anticipated to keep the policy rate unchanged at 1.0%. Market attention has now fully shifted to Governor Kazuo Ueda's press conference and the quarterly Outlook Report for crucial signals regarding the timing of the next interest rate increase.
As Governor Ueda was absent from the previous meeting due to illness, this press conference presents the first direct opportunity for the market to assess his policy stance.
According to a report from Morgan Stanley on July 21, Ueda's remarks—particularly any divergence between his personal views and the stance of the central bank's Monetary Affairs Department—are expected to be the primary driver of market pricing for the rate hike path in the near term. Current market pricing implies probabilities of about 24% for a September hike and approximately 68% for an October hike.
Morgan Stanley's baseline scenario continues to project a rate hike in December, maintaining a pace of roughly one hike every six months, while viewing an October hike as a risk scenario. Furthermore, if the market interprets this meeting as dovish, the Japanese yen could face renewed broad depreciation pressure, increasing the risk of foreign exchange intervention by authorities.
On Tuesday, the USD/JPY pair broke above the 163 level, reaching this mark for the first time since 1986.
July Meeting on Hold, Focus Turns to Next Steps
Morgan Stanley expects the Bank of Japan to maintain its policy rate at 1.0% during its monetary policy meeting scheduled for July 30-31. With a rate hike having just been implemented in June, a pause in July is already widely priced in by the market. The core question now is the signal for the timing of the next rate increase.
The central bank's confidence in the resilience of both external and domestic demand is strengthening, while it remains vigilant about potential upside risks to inflation.
Regarding external demand, robust global demand for AI and semiconductors is not only boosting actual exports of related goods but also supporting export prices, partially offsetting the deterioration in terms of trade caused by rising oil prices. On the domestic front, the central bank's consumption activity index remains steady, and private consumption is expected to be assessed as resilient, with service consumption being the primary support.
Regarding its inflation assessment, the central bank is expected to maintain the language added in the June meeting. This language suggests that the pass-through of corporate goods prices to consumer prices may proceed at a relatively fast pace, with a risk of spreading to a wide range of consumer goods, indicating that "core CPI inflation risks deviating upward from the price stability target of 2%."
Three Factors Underpin December as the Baseline for a Hike
Despite a clearly hawkish stance, Morgan Stanley remains cautious about an earlier rate hike within the year, citing three main reasons.
First, there are doubts about the strength of underlying inflation. Monthly CPI data shows private service inflation has been relatively stable. The demand-stage producer price index as of May and recent high-frequency price indicators suggest that the pass-through of corporate goods prices to the consumer side remains gradual.
Second, uncertainty surrounding the Middle East situation has intensified again. If retail price pass-through continues to be slow while prices of crude oil and naphtha-related products rise further, worsening terms of trade could weigh on nominal GDP and corporate profit growth, potentially creating downside risks for future wage growth. Governor Ueda's past remarks in press conferences indicate a tendency to take a cautious, assessment-oriented stance on Middle East risks.
Third, political considerations are at play. A Reuters corporate survey in July showed that 49% of responding firms felt the Bank of Japan's rate hike to 1% had a "significantly negative" or "somewhat negative" impact on them, with 28% stating the current rate level is already negatively affecting capital expenditure. As the survey sample consisted of large firms with capital of at least 10 billion yen, the actual impact on small and medium-sized enterprises could be greater. Furthermore, the Prime Minister's office emphasizes the goal of building a "strong economy," implying the central bank needs to assess the impact of rate hikes more cautiously.
Three Key Points in the Outlook Report
There are three core issues worth particular attention in this Outlook Report.
First, how the central bank presents the progress of the logic behind the June rate hike, specifically the potential upside inflation risk from the pass-through of corporate goods prices to the consumer side. Data shows the year-on-year increase in the Corporate Goods Price Index has been widening, rising from 5.4% in April to 6.6% in May and further to 7.1% in June. Based on historical patterns, the peak effect of corporate goods price pass-through to consumer prices typically appears about six months later.
Second, whether there is any change in the policy board members' assessment of the balance of risks. If inflation forecasts are revised down while growth forecasts are revised up, the market will closely watch whether the risk balance still tilts towards potential upside inflation. Additionally, this meeting marks the first time new board members Sato and Asada will participate in the Outlook Report meeting. Asada already expressed a cautious stance at the June meeting, while Sato's policy leanings will be tested by the market for the first time.
Third, whether the central bank provides an analytical framework for further rate hikes above 1%. The internal perception of the neutral interest rate range within the bank has effectively shifted upward to around 1.5% to 2.0%, making the previous lower bound of 1.1% no longer a valid reference for policy discussion. In this context, whether the bank can provide more specific measures for the degree of monetary easing will be an important basis for judging the future rate hike path.
Ueda's Press Conference Wording May Be Key for Market Pricing
The nuances in Governor Kazuo Ueda's wording throughout the press conference are likely to be a key variable for near-term market pricing. The opening statement and the first half of the Q&A session may reflect more of the Monetary Affairs Department's stance, while the latter half of the Q&A could better reveal the Governor's personal judgment—subtle differences between the two warrant close attention.
On the issue of weighting inflation data, the market will observe whether the central bank leans more towards actual inflation data like the Corporate Goods Price Index and CPI, or inflation expectation indicators, to determine the timing of rate hikes.
Furthermore, if Governor Ueda makes a clearer statement regarding the risk that "delaying a rate hike could raise inflation risk premiums and push up long-term interest rates," it would also provide important clues for potential trade-offs in future policy discussions.
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