Will Japan raise interest rates in December? The market is closely watching the Bank of Japan Governor's speech next Monday.

Market attention is focused on next Monday's speech by Bank of Japan Governor Kazuo Ueda.

According to Chasewind Trading Desk, Nomura Securities’ research team pointed out in their latest weekly report on November 29th that the probability of a Bank of Japan rate hike in December has surged from less than 20% last week to more than 50%.

The report believes that behind this shift in expectations lies deep concern among Bank of Japan officials over the side effects of maintaining ultra-low real interest rates.

Analysis notes that, for investors, next Monday (December 1st) when BOJ Governor Kazuo Ueda speaks in Nagoya will be a decisive moment, as the market will look for the latest assessment on the spring wage negotiations outlook and underlying inflation trends.

The report emphasizes that the USD/JPY pair consolidated around the 156.50 level this week, but with expectations of a Fed rate cut in December rising, the yen's trend may witness a major turning point.

Market Direction Shifts: December Rate Hike Expectations Soar Above 50%

This week, USD/JPY trading was relatively quiet, fluctuating narrowly around the 156.50 level, in stark contrast to last week’s attempt to break 158. Yet, beneath the calm surface, the market's pricing of a Bank of Japan rate hike in December has been quietly transforming.

Three key factors driving the shift in market expectations include:

BOJ officials collectively turning hawkish. After centrist committee members Koeda and Masuda leaned toward a rate hike soon last week, long-time dovish policy board member Noguchi also voiced concerns this week over the side effects of delaying policy normalization.

Frequent signals released by media reports. Jiji Press reported that continued yen weakness will support a BOJ rate hike, as it may impact Japan’s underlying inflation.

According to reports, former BOJ official Momoi believes the probability of a rate hike in December is “quite high.” WallstreetCN previously mentioned that Reuters pointed out the BOJ is preparing the market for a rate hike soon, as the impact of yen weakness has surpassed political considerations.

Government’s reduced tolerance for a weaker yen. Nomura Securities believes that given the current weakness of the yen, the Japanese government’s tolerance for further BOJ rate hikes may have increased.

As emphasized previously, a weak yen could become the government’s “Achilles’ heel”; Finance Minister Katayama’s verbal interventions are beginning to display growing worries over yen depreciation.

Side Effects of Japan’s Prolonged Low Real Interest Rates Increasingly Apparent

The fundamental reason why BOJ policy board members are increasingly inclined toward another rate hike is that they believe excessively low real interest rates could have adverse effects on the Japanese economy.

Data shows that Japan’s real interest rate is not only at the lowest level among major developed economies but is also significantly below the BOJ’s own estimate of the natural rate.

This abnormally low real interest rate level is one of the main reasons encouraging the market to bet against the yen. Although FX policy is administered by the Ministry of Finance (MOF), BOJ Governor Ueda and other officials are concerned that the impact of exchange rates on underlying inflation may already be greater than in the past.

Yen Depreciation and Cost Pass-through Change the Game

Unlike during deflationary eras, Japanese companies have recently demonstrated a much stronger willingness to pass on rising input costs to final sales prices, which the BOJ pointed out in its October analysis.

In this scenario, the growth and FX pass-through effects may be greater than estimates based on long-term data samples. This is also reflected in the recent steepening of Japan’s Phillips curve.

According to WallstreetCN, the latest data also supports this.

October’s Services Producer Price Index (PPI) shows inflation rates in labor-intensive sectors remain high, in the 3% range. Even after removing volatile items, general services sector CPI inflation remains stable around 2%.

Nomura believes that for the BOJ, the risk is that if nominal interest rates (currently at 0.50%) stay too low for too long, this could, through channels such as yen depreciation, lead to higher inflation and, ultimately, provoke a further decline in real interest rates, creating a vicious cycle.

The report stresses this is exactly what policymakers are worried about.

Two Key Watching Points for Ueda's Speech Next Monday

Amid BOJ officials’ ongoing signals, Governor Kazuo Ueda is scheduled to deliver a speech on December 1st. Nomura Securities highlights the following two points:

The first is the latest assessment of the spring wage negotiations. This was a key phrase Ueda used at the October post-meeting press conference, and related comments are crucial for judging the timing of the BOJ’s next rate hike.

As Ueda’s speech will be held in Nagoya—the center of Japan’s auto industry—he may receive the latest information from top executives in Japan’s core auto sector.

If he makes positive comments about spring wage increases, the market will likely interpret this as a signal for a December rate hike.

The second is the latest view on Japan’s underlying inflation.

As of mid-November, Ueda assessed Japan’s underlying inflation as “gradually rising toward 2%.” However, policy board member Koeda recently described underlying inflation as “around 2%,” revealing different perspectives.

If Ueda upgrades his assessment of underlying inflation (i.e., signals it is closer to 2% than previously thought), the market will see this as a hawkish statement.

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