Japan's interest rate hike in October? The key is "whether Shigeru Ishiba will step down at that time"

The possibility of the Bank of Japan raising interest rates in October is emerging, but the final decision seems to be not entirely in the hands of monetary policy makers, but closely linked to the political fate of Prime Minister Shigeru Ishiba.

According to reports from the Wind Trading Desk, Nomura Securities analysts Tomoaki Shishido and Tomoya Narita pointed out in a report that the recent remarks by Bank of Japan Policy Board member Junko Nakagawa suggested that the monetary policy meeting in October may make a decision to raise interest rates. This statement has been interpreted by the market as a correction to previous dovish expectations, significantly increasing the probability of policy tightening in the short term.

However, the window for monetary policy is being severely squeezed by political uncertainty. Nomura believes that if Prime Minister Shigeru Ishiba's government can last until October, the likelihood of a rate hike will be higher. Conversely, if the ruling Liberal Democratic Party holds an early leadership election leading to a government change, the Bank of Japan will need time to assess the policy intentions of the new cabinet, which will likely delay the decision to raise interest rates.

Hawkish Signals from the Bank of Japan Reemerge

The market's expectations for an interest rate hike in October are directly fueled by the subtle changes in the recent wording of Bank of Japan officials. Policy Board member Junko Nakagawa stated in a speech on August 28 that "if economic activity and price outlook are realized, the Bank will continue to raise policy rates 'accordingly'."

The report emphasizes that this wording has returned to the expressions used before the impact of U.S. tariffs. Previously, due to trade frictions, Bank of Japan officials were more cautious in their wording, generally using "based on the improvement of economic activity and prices" as a premise for raising interest rates.

The report points out that this marks a lowering of the threshold for the Bank to raise interest rates in terms of wording, meaning that as long as the economy meets expectations, even if growth momentum or potential inflation weakens, a rate hike may still occur.

Additionally, Junko Nakagawa also emphasized the importance of the September Tankan survey to be released on October 1, which seems to correct a previous market view—that the Bank does not have enough data to assess the economic situation before the October meeting.

Analysts expect that the statements from Bank of Japan Deputy Governor Ryozo Himeno and Governor Kazuo Ueda after the September meeting may further clarify the "live meeting" nature of the October meeting.

Political Variables Become the Biggest Constraint

Although the economic conditions for a rate hike and the Bank's hawkish tendencies seem to be paving the way, political factors constitute the greatest uncertainty.

The report bluntly states that the key to whether there will be a rate hike in October lies in Japan's political situation.

The report analyzes that if Shigeru Ishiba's government can survive, the likelihood of the Bank of Japan raising rates in October will be greater. However, if there is a change in the leadership of the Liberal Democratic Party, even if the new Prime Minister's monetary policy views are almost identical to those of Shigeru Ishiba, the Bank will need time to confirm the intentions of the new government. Considering the time required to confirm intentions, there may not be enough time before the October meeting.

The report adds that if Sanae Takaichi, who holds a cautious stance on rate hikes, becomes the new Prime Minister, or if a coalition government reshuffle leads to Yuichiro Tamaki, the leader of the Constitutional Democratic Party, becoming Prime Minister, then not only in October but throughout 2025, raising rates may become difficult

Ruling Party Election May Be Advanced, Financial Risks Intensify

The political uncertainty is exacerbated by the possibility that the Liberal Democratic Party (LDP) may hold a leadership election earlier than expected.

According to a survey by the Yomiuri Shimbun, out of 297 LDP lawmakers, 276 responded, with 120 (about 40%) supporting an early election. This makes the likelihood of an early party leader election "quite high."

Nomura believes that the scenario where the Shigeru Ishiba government continues to govern and leads to a flattening of the yield curve is "very few," while scenarios that could lead to a steepening of the curve are "many."

For example, if Sanae Takaichi becomes Prime Minister, or if a coalition government discusses large-scale consumption tax cuts and other fiscal expansion measures, it could heighten market concerns about the widening fiscal deficit, thereby pushing up long-term bond yields and making the yield curve steeper.

In the face of this complex situation, Nomura Securities maintains its main scenario forecast that the Bank of Japan will raise interest rates by 25 basis points in January 2026, with a probability of 60%. However, the institution also assigns a higher probability of 30% to the "secondary scenario," where the central bank raises rates by 25 basis points in October 2025 and April 2026