By Leika Kihara

TOKYO (Reuters) – The Bank of Japan (BOJ) concludes a two-day policy meeting on Thursday. This follows the ruling coalition's loss in a recent election, increasing political uncertainty and complicating the BOJ's plans to reduce monetary stimulus.

Is the BOJ Going to Raise Interest Rates?

The BOJ ended negative interest rates in March, raising its short-term policy target to 0.25% in July. There are indications that they are ready to increase rates again, provided there is confidence that Japan will sustainably reach its 2% inflation target.

With inflation stable around 2% and showing few signs of acceleration, the BOJ is not in a hurry to make changes. The central bank is expected to keep rates steady at this October meeting, as Governor Kazuo Ueda emphasizes the need to assess risks, including uncertainties surrounding the U.S. economy and volatile markets.

The BOJ may also prefer to wait until the situation regarding Japan's future government is clearer.

What Should Markets Look Out For?

The BOJ has stated it will hike rates if the economy and prices align with its forecasts. Therefore, the upcoming quarterly report, detailing fresh growth and price forecasts, may provide insights about future rate hikes.

Sources indicate that significant adjustments to the inflation forecast—projected to stay around the 2% target through March 2027—are unlikely. While these projections support potential rate hikes, the BOJ may indicate a cautious approach by emphasizing risks like slow global growth and the adverse effects of market volatility on consumer and corporate sentiment.

If the BOJ underscores these risks in the report’s policy guidance section, the likelihood of a year-end rate hike could diminish. However, increased optimism regarding sustained wage hikes could signal the approach of the next rate increase.

What Else Should Markets Look Out For?

Governor Ueda’s post-meeting briefing at 3:30 p.m. Tokyo time (0630GMT) may reveal insights into the pace and timing of upcoming rate hikes. In a previous briefing in September, Ueda suggested the BOJ could take time assessing risks, particularly regarding the U.S. economic outlook.

Ueda might adopt a more neutral tone owing to lessened concerns over a potential U.S. recession, while needing to deter speculators from significantly weakening the yen. The dollar reached three-month highs near 153.50 yen on Tuesday as investors sold the yen, anticipating that political uncertainty post-election would delay any rate hikes from the BOJ.

Recent yen declines could prompt Ueda to caution about the upward pressure on import costs and inflation that these moves could engender.

What Do Analysts Think About Next Rate Hike Timing?

After the October meeting, the BOJ will meet again for a policy review on December 18-19, followed by another on January 23-24. A slight majority of economists polled by Reuters believe the BOJ will not raise rates this year, with most expecting a hike by March of the following year.

What Could Hinder Further Rate Hikes?

The BOJ has indicated a willingness to raise rates to neutral levels for the economy—seen as approximately 1%—by late next year or early 2026. The IMF has also urged a gradual monetary policy tightening, projecting rates to reach 1.5% by 2027.

However, challenges lie ahead. The BOJ hopes that significant wage increases from companies this year will support consumer spending and allow for continued price hikes. Yet, slowing global demand may discourage manufacturers from providing substantial pay raises next year.

Additionally, political dynamics may complicate the BOJ’s rate-hike trajectory. The ruling coalition's loss in the lower house may compel Prime Minister Shigeru Ishiba’s administration to court smaller opposition parties advocating for an ultra-loose monetary policy.

While Ishiba is generally seen as supportive of gradual normalization, his diminished political strength may create hurdles for further BOJ rate hikes. Market dynamics—as well as potential fallout from the upcoming U.S. presidential election—could also influence timing.