BOJ Likely to Raise Rates in October... Is the Era of Ultra-Low Interest Rates Ending?

Two BOJ Board Members Signal 'Rate Hike'
Bond Market Also Prices In Possibility of Rate Increase
Tankan and Sakura Report Key to Rate Decision

Expectations are mounting that the Bank of Japan (BOJ) will raise its policy rate again at the monetary policy meeting scheduled for next month, marking the first increase in nine months. This outlook has gained traction after two policy board members proposed a 0.25 percentage point hike at last week’s meeting, and the BOJ decided to begin selling its holdings of exchange-traded funds (ETFs), which is being interpreted as a 'signal' for a rate hike. The market is also reflecting the possibility of a rate increase in advance, as seen in the 10-year government bond yield reaching its highest level since 2008.

Reuters Yonhap News

The Nihon Keizai Shimbun (Nikkei) reported on the 29th, "The overnight index swap (OIS) market is pricing in a 60% probability of a rate hike in October," adding, "Given that this was around 30% before the September meeting, expectations for a rate increase are rising rapidly."

Previously, at the September meeting, board members Hajime Takata and Naoki Tamura opposed keeping the policy rate unchanged and proposed a 0.25 percentage point increase, further strengthening the case for an October hike. Nikkei analyzed, "Proposals from policy board members are often interpreted as a signal for a rate hike at the next meeting." In fact, when the BOJ raised rates last January, board member Tamura had also proposed a rate hike at the preceding December meeting. The market views the BOJ as sending an early signal for a hike through these two members, aiming to manage market sentiment.

The BOJ's decision to begin selling ETFs and real estate investment trusts (REITs) is also being interpreted as a move to foreshadow an additional rate increase in the near future. Nikkei explained, "This action is intended to highlight the normalization of monetary policy, and it is also being seen as a signal for an early rate hike."

The likelihood of a rate hike being derailed for political reasons also appears low. Nikkei reported that Shinjiro Koizumi, Minister of Agriculture, Forestry and Fisheries, who is favored to win the Liberal Democratic Party leadership election on the 4th of next month, is expected to respect the BOJ’s decision. Sanae Takaichi, former Minister for Economic Security, who previously stated, "It would be foolish to raise rates now," has also refrained from making any particular comments on BOJ policy this time.

As expectations for a rate hike spread, Japan’s long-term interest rates have climbed to their highest levels in 17 years. On the 22nd, the 10-year government bond yield surged to 1.65% during trading hours, reaching its highest point since July 2008. On the same day, the 2-year yield also exceeded 0.93%, marking the highest level since June 2008.

Some analysts predict that if rates are raised next month, Japan’s long-term yields could approach 1.5%. Former BOJ board member Makoto Sakurai forecasted, "By the end of Governor Ueda’s term (early 2028), the BOJ will have raised rates at least four times, reaching around 1.5%." This is interpreted as a signal that the BOJ is moving away from its ultra-low interest rate policy and beginning a gradual normalization of rates.

The key variable will be the economic indicators to be released early next month. The Tankan business survey for the third quarter and the so-called 'Sakura Report' are seen as crucial factors in determining whether a rate hike will occur. The Tankan, a survey reflecting Japanese companies’ business sentiment, will announce its third-quarter results on the 1st of next month. Then, at the branch managers’ meeting on the 6th, the regional economic report known as the 'Sakura Report' will be released. The BOJ is scheduled to hold its two-day monetary policy meeting on the 29th and 30th of the same month.