The Bank of Japan may raise interest rates as early as October! Political turmoil is unlikely to change the pace of monetary tightening

According to sources familiar with the matter, officials from the Bank of Japan (BOJ) believe that it is possible to raise the benchmark interest rate again within this year, even if there is political instability in Japan, as the current economic development is consistent with their previous expectations.

Media reports indicate that with the signing of the US-Japan trade agreement, a key uncertainty has been eliminated. However, according to these sources, the BOJ is expected to maintain the interest rate at 0.5% during the next monetary policy meeting on September 19, as officials are still assessing the impact of the US tariffs on the Japanese domestic and global economy. The BOJ's policy committee will also hold meetings in October and December.

Following the announcement of this news, the yen extended its gains, rising to 146.29 against the dollar, the highest level since August 22, before sliding back to around 147.40. The currency market currently predicts a 64% probability that the BOJ will raise interest rates before December, compared to just 44% on Monday.

Earlier this week, Japanese Prime Minister Shigeru Ishiba announced his resignation, casting a shadow over Japan's political landscape and government policy outlook. Some economists warn that to win public support, the government may introduce more fiscal spending, disrupting the fiscal discipline of the ruling coalition. Nevertheless, analysts believe that Japan's economic performance remains in line with expectations, steadily progressing towards the stable inflation target set by the BOJ. The US-Japan trade agreement signed last month has also alleviated some potential risks to economic growth.

These officials believe that after raising interest rates in January this year, the BOJ is gradually moving towards the next rate hike. According to some sources, some officials even believe that a rate hike could happen as early as October.

Data in the Coming Months Will Be Crucial

The recently released revised data on Japan's GDP shows that moderate growth continues. Against this backdrop, overall profits of Japanese companies reached a record high last quarter, and the labor market remains tight, pushing wages up across various industries. Japan's real wages saw their first increase in seven months in July, and the minimum wage is also set to record the largest increase in history.

These sources indicate that especially after the US-Japan trade agreement, closely monitoring economic data and information in the coming months will be crucial, as the BOJ may use this to determine whether the economy is ready for another rate hike.

However, this view differs slightly from the market's perspective earlier this week. Following Shigeru Ishiba's resignation announcement, overnight swap market pricing showed that the probability of a BOJ rate hike within the year dropped to about 50%, down from around 70% earlier this month.

In September last year, popular Prime Minister candidate Sanae Takaichi stated that raising interest rates "would be absurd" under the current circumstances. Her remarks were made before the last Liberal Democratic Party presidential election. The market is currently betting on her potential victory, and regardless of who wins, increased fiscal spending is likely, which has led to a rise in the Japanese stock market this week, with ultra-long-term government bond yields remaining close to historical highs Informed sources told the media that Bank of Japan officials will closely monitor signals from the new government, particularly regarding the economic measures the government commits to implement and how these measures will affect economic growth, inflation, and financial markets. They indicated that a significant increase in government spending could drive up inflationary pressures, thereby influencing the timing of the next interest rate hike.

Previously, Japan's inflation rate has remained at or above the Bank of Japan's target level of 2% for more than three consecutive years. Last month, U.S. Treasury Secretary Scott Bessent stated that the Bank of Japan is "behind the curve" in addressing inflation. However, Bank of Japan Governor Kazuo Ueda has repeatedly denied this claim, stating that Japan's core inflation rate remains below the central bank's target.

Informed sources also told the media that the Bank of Japan is closely watching the trends in the U.S. economy, particularly whether the U.S. can achieve a "soft landing" following recent weak employment data.

Last week, after a speech by Bank of Japan Deputy Governor Noriyuki Himi, traders generally perceived his remarks as dovish. However, according to some informed sources, some officials believe his policy stance is actually neutral