BoJ to Opt for Conventional Rate Hike Amid Inflation Concerns

The Bank of Japan (BoJ) is unlikely to raise interest rates by 50 basis points in September, despite inflationary pressures, as it seeks to avoid shocking markets and allow itself time to assess the impact of higher rates on corporate and household activity. According to sources familiar with the central bank's thinking, a bigger-than-usual hike could be seen as a sign of desperation and put the market's focus on the risk of the BoJ being behind the curve in dealing with inflation.

The BoJ has raised its policy rate by 25-basis points increments at a pace of roughly twice a year since starting its current tightening cycle in 2024. With the Middle East conflict, a tight domestic job market, and rising import costs from a weak yen driving up inflation, the bank is considering speeding up the pace of rate hikes to roughly once a quarter.

However, BoJ governor Kazuo Ueda said last week that economic and price conditions were moving roughly in line with projections, suggesting inflation risks have not heightened enough to justify a bigger-than-usual hike. Recent data shows the economy hardly needs aggressive monetary tightening aimed at cooling red-hot demand, and financial conditions remain accommodative.

Some dovish board members may see a stronger need to move cautiously as the BoJ's policy rate approaches levels deemed neutral to the economy, estimated by its staff as sitting between 1.1% and 2.5%. Board member Toichiro Asada, the sole dissenter to the BoJ's decision in June to raise rates to 1%, wants to see demand-driven inflation before supporting rate increases.