No interest rate hike, but there is a significant change at the Bank of Japan

Deutsche Bank believes that future fluctuations in the yen's exchange rate will become a key indicator for predicting the timing of interest rate hikes.

According to news from the trading desk, on October 30, Deutsche Bank published a research report stating that the Bank of Japan maintained its interest rate at the same level in October but conveyed a key signal of policy shift — future emphasis will be placed more on actual inflation rather than just potential inflation.

The report analyzes that this signal means that if the yen continues to depreciate and push up actual inflation, the central bank may accelerate the pace of interest rate hikes. Conversely, if actual inflation falls below the 2% target, the interest rate hike process may be delayed until after April 2026.

Deutsche Bank emphasizes that if the USD/JPY approaches 160, the probability of a rate hike in December will significantly increase. It also maintains its previous forecast that there will be rate hikes of 25 basis points in January 2026, July 2026, and January 2027, with the policy rate ultimately reaching 1.25%.

Bank of Japan Holds Steady

The Bank of Japan maintained its current policy interest rate at the monetary policy meeting on October 30 as expected.

The report points out that committee members Naoki Tamura and Haruhiko Takeda again proposed interest rate hikes, consistent with the situation during the September meeting, indicating that there is still a hawkish voice within the central bank, but this did not change the final policy decision.

Additionally, the newly appointed Minister of Economic and Fiscal Policy, Toshitaka Kinoshita, attended this meeting. It remains unclear whether his attendance influenced the discussions, and further details will need to be obtained from the subsequent release of the "Summary of Opinions" and the meeting minutes.

In the concurrently released "Economic and Price Outlook Report," the central bank made slight adjustments.

The report raised the median growth rate forecast for the fiscal year 2025 by 0.1 percentage points and the median core CPI inflation forecast for the fiscal year 2026 by 0.1 percentage points.

However, due to the small magnitude of the 0.1 percentage point change, the report's main text still states that it is "basically unchanged from the July outlook." This constitutes a "slightly dovish surprise" for the market's previous expectation of a 0.2 percentage point upward adjustment in growth and inflation forecasts.

In terms of risk balance, the report believes that economic growth faces higher downside risks, while inflation risks are balanced on both sides, with no significant changes from the July assessment. However, the number of committee members who believe there is an upside risk to inflation remains at three, while those who believe there is a downside risk decreased from three in July to two.

Deutsche Bank analyzes that if by the time of the next outlook report in January next year, one more committee member shifts to believe that upside risks are significant, or if one member who believes downside risks are significant is reduced, then the risk balance for inflation may be judged as "tilted to the upside," which could become an excuse for the central bank to initiate interest rate hikes.

The Real Change: Policy Focus Shifts to "Actual Inflation"

Deutsche Bank points out that the biggest change in this Bank of Japan meeting lies in the shift in the focus of policy assessment revealed in the "Outlook Report." The summary section of the report clearly states:

……It is expected that the potential CPI inflation rate and the year-on-year increase in CPI (excluding fresh food) will gradually rise, and in the latter half of the forecast period, will be at a level consistent with the price stability target This is significantly different from the statement in the July report, which stated:

Subsequently, as the economic growth rate rises, the sense of labor shortage is expected to intensify, medium- to long-term inflation expectations will rise, and potential CPI inflation is expected to gradually increase. In the latter half of the forecast period, potential CPI inflation may reach a level that is basically consistent with the price stability target.

Deutsche Bank interprets this as the Bank of Japan placing greater emphasis on clear signals of actual inflation, in addition to potential inflation, when assessing the price stability target. This change was hinted at in the speech by Bank of Japan Governor Kazuo Ueda on October 3.

The summary of opinions from the July monetary policy meeting noted:

When potential inflation is significantly below 2%, its importance in policy decision-making is greater than that of actual inflation. However, as potential inflation approaches 2%, the importance of actual inflation gradually increases.

Research analysis indicates that since the Bank of Japan predicts that "the year-on-year increase in CPI (excluding fresh food) may slow to below 2% in the first half of fiscal year 2026," it is highly likely that the central bank will not rush to raise interest rates after April 2026.

The probability of a rate hike by the Bank of Japan in January is greater than in December

Bank of Japan Governor Kazuo Ueda's overall tone at the post-meeting press conference was dovish, and he did not release any signals suggesting a rate hike in December.

He reiterated that although the certainty of achieving economic outlook is increasing, he wants to see more data, especially the "negotiation momentum" of next year's "Shunto" (spring labor negotiations). This suggests that a rate hike in the December meeting is quite difficult.

Deutsche Bank believes that compared to December, the January 2026 meeting is more likely to be the timing for a rate hike. Reasons include:

• Policy Coordination: The government has just finalized economic measures, and a subsequent rate hike by the central bank would appear inconsistent with policy.
• Information Completeness: By January, information regarding the "Shunto (spring labor negotiations)" will be clearer, and reports from the central bank's regional branch managers will also provide important references. A new "Outlook Report" will also be released at that time.
• Timing Window: The January meeting may occur during the parliamentary recess, providing a better window for the central bank to communicate fully with the government.

Therefore, Deutsche Bank maintains its core forecast: The Bank of Japan will raise interest rates by 25 basis points in January 2026, July 2026, and January 2027, with the final policy rate reaching 1.25%.

However, the research report emphasizes that exchange rates are the biggest variable. If the yen continues to depreciate, causing the USD/JPY exchange rate to approach the psychological threshold of 160, the likelihood of a rate hike in December will significantly increase in order to curb imported inflation.

Additionally, if the government intervenes in the foreign exchange market to buy yen, it will also make it easier for the central bank to take rate hike actions from the perspective of policy consistency.