Bank of Japan Decision Commentary: Expectations for further rate hikes have cooled; the upper limit of interest rates may be below 2%.

Bank of Japan Decision Commentary: Expectations for further rate hikes have cooled; the upper limit of interest rates may be below 2%.

The Bank of Japan raised interest rates as expected, but two dissenting votes led the market to reassess the end of the tightening path.

The Bank of Japan (BOJ) held its monetary policy meeting on September 17-18, deciding by a 7-2 majority to raise the policy rate by 25 basis points to 1.25% , in line with market expectations. However, the dissenting votes of two committee members triggered a repricing of the rate hike outlook in the market, leading to a weaker yen and a steeper yield curve.

Following this rate hike, market expectations for further increases have cooled somewhat . According to Citigroup research, the likelihood of terminal interest rates remaining at or below 2% has increased . Goldman Sachs believes that this statement did not release a clear signal of a faster pace of rate hikes; financial conditions remain in an accommodative range, and the process of policy rates converging towards the neutral rate will continue, but the pace is expected to remain gradual.

It passed by a vote of 7 to 2, with the dissenting votes drawing market attention.

Bank of Japan Policy Board members Toichiro Asada and Ayano Sato voted against raising interest rates, advocating for maintaining the current rate. According to Citigroup research, these two dissenting votes highlighted clear resistance from the "reflation faction" within the Policy Board and directly impacted market expectations for rate hikes—following the meeting, the OIS market's pricing of future rate hikes immediately declined.

The current market consensus points to the Bank of Japan raising interest rates again to 1.50% at its December meeting. However, Citigroup research points out that the threshold for raising rates twice in a row remains high, with the dollar and euro markets pricing in a 50% probability of a rate hike at their respective October meetings, making it even less likely that Japan will follow suit.

Goldman Sachs stated that the statement retained the phrase "financial conditions are expected to remain accommodative following the adjustment of the policy rate," consistent with the wording after the June rate hike, suggesting that there is still room for interest rates to move towards a neutral level. The forward guidance also maintained the statement "policy rates will continue to be raised and the degree of monetary accommodativeness will be adjusted," indicating that the intention to raise rates remains unchanged, but there are no signs of an accelerated pace.

Terminal interest rates may be capped at below 2%.

This rate hike has pushed the policy rate into the lower end of Goldman Sachs' estimated neutral rate range (1.1% to 2.5%). However, Citigroup research believes that given the neutral rate is estimated at around 2% or slightly higher, and the policy rate is gradually approaching this level, the Bank of Japan will need to more carefully assess the market impact and inflation trends, and the pace of rate hikes is expected to slow down.

Political factors also pose an additional variable. Citigroup research points out that despite the cabinet reshuffle, the retention of Economic and Fiscal Policy Minister Minori Kiuchi indicates that the Takaichi government's reflation stance remains unchanged. If this political environment persists, the successor to policy committee members Hajime Takata and Naoki Tamura may also favor a reflationist stance. In this case, even with a narrow 5-4 majority, raising interest rates would still be possible, but the threshold would be significantly higher.

Citigroup Research believes that, against this backdrop, pushing the policy rate to 2% by July next year may become a priority, and the probability of the terminal rate being capped at 2% or below has increased significantly.

The assessment of upside risks to inflation remains unchanged.

Regarding inflation assessment, the Bank of Japan maintained its assessment since the July outlook report, listing the Middle East situation, AI-related demand, and a weaker yen as the three major upside risks to prices, and believes that these factors "still need to be monitored."

The statement also retained the wording from the June monetary policy meeting, namely that "there is a risk that underlying CPI inflation will deviate above the 2 percent price stability target."

Goldman Sachs stated that the focus of attention regarding Governor Kazuo Ueda's press conference will be on whether the Bank of Japan considers itself to be lagging behind the yield curve—a judgment that will directly affect the pace of future interest rate hikes.

The bank expects Kazuo Ueda not to believe that current policies are out of step with the curve, and his statements on the upside risks to inflation, the level of neutral interest rates, and the possibility of an economic slowdown triggered by interest rate hikes are not expected to change significantly compared to the July meeting.

Japanese bonds offer significant long-term investment value.

Regarding interest rate strategy, Citi Research maintains a positive view on long-term Japanese government bonds. If inflation stabilizes around 2%, a 3% yield on 10-year Japanese government bonds would be reasonable, making it attractive to real money investors . If the policy rate does not fall below 2%, the 3% yield level is expected to provide support.

Citigroup Research maintains a positive stance on ultra-long-term Japanese government bonds. Supply and demand remain robust, with no increase in ultra-long-term bond issuance expected in the next fiscal year, and the yield curve is likely to continue its flattening trend. The strength in overseas markets over the past week has also provided additional support. However, Citigroup Research believes that rising short- to medium-term interest rates will dominate near-term market movements, and a rebound in ultra-long-term Japanese government bonds is unlikely before next year at the earliest.

In addition, the Bank of Japan has adjusted the "Operation Climate Change Response Financing Support" by introducing a floating interest rate mechanism and setting the overall limit at 50 trillion yen, with a limit of 10 trillion yen for a single counterparty.

Citigroup Research points out that given the current balance of approximately 25 trillion yen, growth will not stagnate in the short term, but its impact will gradually become apparent as existing "bank loan promotion funding measures" expire.

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