Japan to raise interest rates in October? The key is “whether Shigeru Ishiba will step down by then”

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The possibility of a Bank of Japan rate hike in October is coming to the surface, but the final decision now appears to be not entirely in the hands of monetary policymakers, being closely tied instead to the political fate of Prime Minister Shigeru Ishiba.

According to Chase Wind Trading Desk, Nomura Securities analysts Tomoaki Shishido and Tomoya Narita pointed out in a report that Bank of Japan Policy Board Member Junko Nakagawa’s comments last week signaled that a rate hike decision may be made in the October monetary policy meeting. This was interpreted by the market as a revision of the previous dovish expectations, significantly raising the likelihood of near-term policy tightening.

However, the window for monetary policy is being severely squeezed by political uncertainty. Nomura believes that if Prime Minister Shigeru Ishiba’s government can be maintained until October, the probability of a rate hike will be higher. Conversely, if the ruling Liberal Democratic Party (LDP) holds an early leadership election resulting in a change of government, the Bank of Japan will need time to assess the new cabinet’s policy intentions, thus likely delaying the rate-hike decision.

BOJ Hawkish Signals Re-emerge

Expectations of a rate hike in October are rising directly due to subtle changes in the wording by BOJ officials recently. On August 28, Policy Board Member Junko Nakagawa said in a speech, "If the outlook for economic activity and prices is achieved, the central bank will ‘accordingly’ continue to raise policy rates.”

The report emphasized that this phrasing marks a return to the language used before the U.S. tariff shock. Previously, amid trade frictions, BOJ officials were more cautious in their wording, generally using "depending on improvements in economic activity and prices" as a precondition for a rate hike.

The report points out that this indicates a lowering of the threshold for a rate hike at the language level: as long as the economy is as expected, even if growth momentum or underlying inflation weakens, a rate hike is still possible.

In addition, Junko Nakagawa also emphasized the importance of the September Tankan survey to be released on October 1, which seems to correct the previous market view that the BOJ did not have enough data to assess the economy before the October meeting.

Analysts expect that statements by BOJ Deputy Governor Ryozo Himeno and Governor Kazuo Ueda after the September meeting this week may further clarify the "live meeting" nature of the October meeting.

Political Variables Become the Biggest Constraint

Although the economic conditions for a rate hike and the central bank’s hawkish tilt seem to be in place, political factors constitute the biggest uncertainty.

The report bluntly says that for a rate hike in October, the political situation in Japan is the key.

The report analyzes that if the Ishiba government can continue, the central bank is more likely to hike in October. But if there is an LDP leadership change, even if the new prime minister’s monetary policy views are almost identical to Ishiba’s, the central bank still needs time to confirm the new government’s intentions. Given the time needed for such confirmation, there may not be enough time before the October meeting.

The report adds that if monetary policy cautious Sanae Takaichi becomes the new prime minister, or if a coalition government reshuffle leads to Democratic Party for the People leader Yuichiro Tamaki taking office, then not only October, but rate hikes for the whole of 2025 could become difficult.

Early Ruling Party Election and Heightened Fiscal Risks

Adding to this political uncertainty is the possibility that the LDP might advance its leadership election.

According to a Yomiuri Shimbun survey, among 297 LDP lawmakers, 276 responded, of whom 120 (about 40%) support holding an early election. This makes the likelihood of bringing forward the leadership election “quite high.”

Nomura believes that compared with Ishiba continuing as prime minister, scenarios where a new leadership would lead to a flattening yield curve are “very few,” while scenarios that might result in curve steepening are “many.”

For example, if Sanae Takaichi becomes prime minister, or if the coalition government discusses large-scale consumption tax cuts or other fiscal expansion measures, this could deepen market worries over expanding fiscal deficits, pushing up long-term bond yields and steepening the yield curve.

Amid this complex situation, Nomura Securities maintains its main scenario forecast: that the Bank of Japan will raise rates by 25 basis points in January 2026, with a probability of 60%. However, the institution also assigns a relatively high 30% probability to a “secondary scenario” in which the BOJ lifts rates by 25 basis points in October 2025 and April 2026 respectively.

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The above highlights are from Chase Wind Trading Desk.

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