TOKYO (Reuters)

The Bank of Japan (BOJ) holds its final policy meeting for the year next week, with its decision coming shortly after the U.S. Federal Reserve's expected interest rate cut.

What to Expect from the BOJ

Will the BOJ Raise Interest Rates?

The BOJ ended negative interest rates in March and raised its short-term policy target to 0.25% in July. It has indicated a willingness to hike rates again if wage and price targets align.

There’s increasing belief within the BOJ that conditions for another rate hike to 0.5% are becoming favorable. The economy is growing moderately, wages are climbing steadily, and inflation has remained above the 2% target for over two years.

However, policymakers seem cautious due to the yen's recovery reducing inflationary pressures and uncertainties surrounding U.S. President-elect Donald Trump’s policies.

The decision to increase rates in December or wait until January 23-24 will depend on the board members' confidence in Japan sustainably reaching the 2% inflation goal.

Comments from BOJ Policymakers

The BOJ board members have been vague about the next rate hike’s timing. Governor Kazuo Ueda mentioned that another hike is near but did not confirm a specific date.

Dovish member Toyoaki Nakamura stated he is open to rate hikes but emphasized that the decision must rely on data.

While there’s a focus on a rate increase by March, current comments imply the BOJ is leaving its options flexible regarding timing.

Market Expectations for the Rate Hike

A little over half of economists in a recent Reuters poll believe the BOJ will raise interest rates in December, with about 90% predicting rates will reach 0.5% by the end of March.

Conversely, markets currently assign a roughly 30% chance to a December rate increase.

Potential Market Reactions

The BOJ's decision will follow the U.S. Federal Reserve's announcement, which is anticipated to cut rates. This difference in rate direction could result in fluctuations in the yen and bond yields.

An increase by the BOJ might strengthen the yen, while a decision to keep rates steady may weaken it. However, yen depreciation could be limited if the market swiftly anticipates a January increase.

Other Considerations for Markets

Regardless of the outcome, Ueda is expected to provide insights on the future rate trajectory and the conditions triggering action during the post-meeting news conference. If rates remain unchanged, he might hint at future tightening to stabilize the yen, while dovish communication might follow if rates are raised to assure markets against rapid tightening.

In addition to the rate decision, the BOJ will present findings on the effects of various unconventional monetary easing methods used during its 25-year anti-deflation campaign, marking a significant step towards reducing its massive stimulus.

The review will suggest that interest rate cuts are a more effective way to combat economic stagnation than unconventional measures, such as those seen under former Governor Haruhiko Kuroda's significant asset-buying scheme.

What Comes Next?

If the BOJ increases rates, it will likely hold steady until at least April, when it releases new quarterly projections extending through fiscal 2027 for the first time.

If they decide against a hike, attention will shift to crucial data and events leading to the January meeting. Ueda may also reveal policy intentions at his speech to business lobby Keidanren on December 25 and Deputy Governor Ryozo Himino's public appearance on January 14.

The BOJ’s quarterly report on regional economies, likely due before the January 23-24 meeting, will provide more insights into whether wage increases are becoming widespread across the country.