BoJ Preview: Forward Guiding Another Hike Imminent

At the October 31 meeting, the BoJ will keep rate unchanged at 0.25% and guide there will be more tightening by suggesting the current inflationary trajectory aligns with BoJ's economic forecast in July 2024. The BoJ has taken a hawkish tilt in the July meeting wth echoes throughout the BoJ officials over the past months, the latest being board member Adachi saying conditions are already in place to start normalizing policy. Combined with the higher than target inflation figure, there is a 50-50 chance for the BoJ to hike in October or December. We favored the later with consideration of the medium term wage/inflation dynamic. The political headwind from new Prime Minister Ishiba have dissipated after he walks back his comment but the October election may be a X factor if the LDP loses majority and is unable to form coalition (unlikely). BoJ also highlighted global economic development and domestic business' wage & price setting behavior as critical area to watch and the impact of foreign exchange development towards domestic prices is increasing.

The July policy tilt has been viewed too hawkish even when headline inflation approaches 3% by us as the underlying shows more cost driven than demand driven inflation, further confirmed by the weak retail trade and household consumption data.  Despite a moderation of headline y/y CPI to 2.6% in September, ex fresh food and energy has risen back above 2%, it suggest there is indeed some underlying strength in inflation and could support the BoJ to stay at the hawkish side of monetary policy. Wage is likely to continue its above average growth from strong 2024 wage negotiation. Yet it is difficult to see the same magnitude of wage hike in 2025 given the restraint in business earnings, not to mention SME already has difficulty mating bigger firms' wage hike in 2024. Moreover, Japanese households have so far turned towards saving instead of splurge at higher prices and thus we believe the impact of wage growth towards inflation will be less than BoJ's expectation. Japanese residents remain reluctant to spend at high prices even when such behavior has shown signs of change. The sluggish private consumption in the first half of 2024 will restrain BoJ's steps towards more tightening. Moreover, PPI continue to stay below 1% four months in a row and is close to zero in July q/q (0.3%), further reducing the impetus for business to raise prices.

Looking at the bright side, we do acknowledge the gradual change in wage/price setting behavior which would drive up the Japanese trend inflation in a long run. Our central forecast continue to see inflation lower than BoJ's forecast and see only one more 25bps hike in the December meeting and two 25bps hike in the first two quarters of 2025.