The Bank of Japan's rate hike this week is certain, and the market fully expects another rate hike before October next year.

Bank of Japan Governor Kawai Shigeta is expected to raise the benchmark interest rate to the highest level in thirty years this Friday, amidst the complexity of future policy paths due to the government's dependence on low-cost financing and the weakening yen pushing up import inflation. Market expectations generally suggest that the Bank of Japan will raise the policy rate by 25 basis points to 0.75% at the end of its two-day monetary policy meeting. This is the first time under Kawai's tenure that economists surveyed unanimously expect an interest rate hike. A survey of 50 economists showed that all of them expect a rate hike this time, and overnight index swap (OIS) pricing also indicates a probability of over 90% for a rate hike this week, doubling compared to the end of October, with the market fully pricing in another rate hike before October 2026. Against the backdrop of this rate hike, the situation for newly appointed Japanese Prime Minister Takamachi Wanae is particularly delicate. Japan's first female prime minister in history, Takamachi had described "raising interest rates" as a "foolish move" last year. However, faced with the pressures of rising living costs, inflation eroding purchasing power, and a decline in the ruling party's support rate, she has avoided openly criticizing Kawai and plans to gradually phase out the ultra-loose policy since taking office in October last year, focusing on controlling inflation. However, the Takamachi government also needs to prevent long-term bond yields from rising too rapidly. The Japanese government is currently preparing the budget for the next fiscal year, which is typically announced in late December. The yield on Japanese 10-year government bonds rose to 1.97% this month, hitting an 18-year high, prompting Kawai to warn publicly last week that the rate of increase in yields was "slightly rapid." Analysts point out that the last time the Bank of Japan's benchmark interest rate was close to the current level, long-term government bond yields were around 3%. If yields approach this level again, it would significantly increase interest payments, bringing greater financial pressure to the Japanese government, which bears the highest public debt burden among developed countries, limiting its policy space to address the cost of living crisis and increase defense spending to meet regional security challenges. Ryutaro Kono, Chief Economist at BNP Paribas Japan, said that considering the Takamachi government's preference for a low-interest rate environment, the Bank of Japan's pace of future rate hikes is expected to be relatively restrained, with hikes likely occurring roughly every six months. However, he also warned that if exchange rate fluctuations intensify, there is a risk that the central bank could be forced to tighten policy more quickly. If the rate hike is implemented this week, it will solidify the Bank of Japan's position as the only major central bank still raising interest rates this year. It will also be the first time since 1998, when the Bank of Japan adopted the current meeting system, that it has adjusted rates in the opposite direction to the Federal Reserve in the same month. Former Director of the International Bureau of the Bank of Japan, Shigeto Nagai, said that this year has been full of changes, and there may still be more turbulence in the future, noting that if Kawai can continue with rate hikes, it will be considered lucky. With market expectations already factoring in the rate hike, investors' focus will shift to Kawai's forward guidance at the press conference. Economic research suggests that Kawai is likely to remain cautious in his wording, avoiding clear implications of a specific timetable for future rate hikes. It is worth noting that internally, the Bank of Japan does not believe that even with an increase to 0.75%, it has reached the so-called "neutral rate." Insiders suggest that some officials believe that even at 1%, the policy stance may still be relatively loose. This implies that in the case of sustained high inflation, there is still room for further rate hikes. Japan's core inflation index has remained at or above the Bank's 2% target for three and a half years, the longest period since 1992, with the weakening yen playing a key role. Companies are passing on higher import costs to consumers, driving up prices. Currently, the yen is hovering around 155 against the dollar, close to the level that prompted the Japanese Ministry of Finance to intervene in the market four times last year. Finance Minister Satsuyama recently stated that forex interventions are still an option, highlighting growing official dissatisfaction with the weak yen. Meanwhile, US Treasury Secretary Bennett has also commented on Japan's policy direction. He has stated that the Japanese government should prioritize allowing the central bank to address inflation through rate hikes before considering direct intervention in the forex market, bluntly stating that the Bank of Japan's actions on inflation are "slow." Even if the rate hike is implemented this week, the Bank of Japan's policy rate will still be only higher than Switzerland among major central banks, ranking second to last. Hideo Hayakawa, former Executive Director and Chief Economist of the Bank of Japan, believes that if not for domestic political changes and the threat posed by US President Trump's aggressive tariff policies on Japanese exports, Kawai may have taken further rate hike actions sooner. "This has been an unlucky year for the Bank of Japan, with the dual background of Trump and Takamachi, forcing the Bank of Japan's policy pace to lag behind the situation."