It is almost certain that the Bank of Japan will raise interest rates this week! The future rate path and reduction of bond purchase program are the focus of the market.

According to information released by the Bank of Japan, Governor Haruhiko Kuroda will be absent from this week's monetary policy meeting as he is hospitalized for treatment. Almost all observers closely following the Bank of Japan expect the central bank to raise the benchmark interest rate by 25 basis points to 1%, the highest level since 1995, at this meeting. If the Bank of Japan's action aligns with market expectations, this will be the first rate hike by the bank since December last year. At the same time, policymakers are grappling with rising inflation risks due to the prolonged Middle East conflict. The market will closely watch for clues on when the Bank of Japan may take action again. Traders are cautious that if the yen weakens after the meeting, the Japanese government may intervene in the forex market. Kuroda's absence from the meeting exacerbates concerns about central bank policy communication Since becoming Governor of the Bank of Japan in April 2023, 74-year-old Haruhiko Kuroda will be missing his first monetary policy meeting and first hospitalization due to health reasons. According to the Bank of Japan's media relations department, Kuroda will express his views through a written statement during the June policy meeting but will not participate in the voting. The Bank of Japan expects Kuroda to be able to attend the July policy meeting after being discharged. The Bank of Japan also added that during the policy meeting on June 15-16, Deputy Governor Masayoshi Amamiya will act as the acting chairman, while Deputy Governor Shinichi Uchida will host the post-meeting press conference. Investors will focus on Uchida, a veteran central bank official who is widely regarded as one of the main architects of the Bank of Japan's policy framework over the past two decades, to see if he will deliver policy signals more directly than the former university professor Kuroda. T&D Asset Management's chief strategist Hiroshi Namyoka said, "Especially in the bond market, investors have become accustomed to Kuroda's communication style - not just what he says, but also his expressions and the atmosphere he creates at press conferences." "Without Kuroda's presence, it may be more difficult to judge the Bank of Japan's true intentions, and bond and forex traders may have a harder time interpreting the central bank's outlook, which could further exacerbate uncertainty." However, there is also a possibility of another scenario - compared to Kuroda, who always sought to maintain balanced expressions, Uchida may provide more explicit information on the future rate path. If the rate hike in this meeting proceeds as expected, the most pressing question for the market will be how soon the Bank of Japan will act next, which will also be a key factor affecting the forex market after the decision is announced on Tuesday. Carol Kong, a forex strategist at the Commonwealth Bank of Australia, said, "A 25 basis point rate hike is almost a certainty. For the market, the bigger question is how Uchida will handle the press conference." "If the Bank of Japan raises rates as expected, it will help reinforce investors' confidence in the bank's independence and also give policymakers more time to assess when the next rate hike will occur." Reducing the asset purchase program Another major focus of this meeting is the Bank of Japan's reduction of its asset purchase program. Currently, the Bank of Japan is gradually reducing its bond purchases by 200 billion yen per quarter as part of its balance sheet reduction program, which will continue until March next year. As concerns over a rapid exit could impact the bond market, the Bank of Japan halved the pace of reduction last year. Despite the ongoing reduction in bond purchase volumes, the Bank of Japan still holds about half of Japan's government bond stock after more than a decade of large-scale asset purchases. In May this year, the yield on Japan's 10-year government bonds rose to its highest level since 1996, highlighting a significant increase in bond market volatility. Earlier this month, Kuroda stated that when formulating future asset purchase plans, policymakers will consider both market function improvement and market stability factors. As conditions in the bond market improve, officials may discuss further slowing down the pace of reduction in bond purchases or even pausing the balance sheet reduction process. Sources have revealed that the Bank of Japan may consider keeping the current bond purchase volume unchanged after the next fiscal year to pause the reduction in asset purchases. Four sources stated that given the progress made in shrinking the massive balance sheet, the Bank of Japan is inclined to pause the reduction in bond purchases. One source stated, "Even if further reduction in purchases is halted, the size of bonds held by the Bank of Japan will significantly decrease merely through natural maturities of bonds." The other three sources expressed similar views. They stated that the Bank of Japan may stop the practice of annually setting out a plan for reducing bond purchases and instead adopt an open arrangement, committing to maintaining monthly bond purchase volumes at 2.1 trillion yen. Masajiro Ando, Chief Economist at Rakuten Securities Economic Research Institute and former BOJ official, said, "A key issue is how the Bank of Japan will articulate its bond purchase strategy while avoiding causing concerns in the bond market or giving the impression that it is succumbing to fiscal policy considerations under the leadership of the government." Sources stated that the decision to pause the reduction in bond purchases may be a close call, as there are divisions within the Bank of Japan's nine-member policy board. Some members wish to prioritize soothing investor sentiment, while others believe that it is necessary to continue steadily reducing asset purchases to shrink the Bank of Japan's large balance sheet. The Bank of Japan is in a bind Shigenobu Nagai, former Director of the International Department at the Bank of Japan and current Director of Japanese Economics at the Oxford Economic Research Institute, stated that the Bank of Japan is facing a dilemma. On one hand, it must avoid angering the government of Prime Minister Sanae Takai, which is becoming increasingly sensitive to the risks of prematurely normalizing monetary policy. On the other hand, the Bank of Japan must also demonstrate to investors that it is not falling behind the situation in the face of increasing inflation risks and a weakening yen. Nagai stated, "At some point, the Bank of Japan may have to make a difficult choice between supporting domestic demand and preventing further yen depreciation." Despite the Japanese government injecting record amounts of funds into intervening in the forex market to support the yen, the USD/JPY exchange rate remains around the key level of 160 yen per dollar, a level that has prompted authorities to intervene in the market many times in the past. For a resource-importing country like Japan, a weak currency will exacerbate inflationary pressures. Pressure from overseas is also increasing. The European Central Bank became the first major central bank to raise interest rates since the outbreak of the US-Iran conflict last week. Traders are increasingly of the opinion that the Federal Reserve may further tighten policy before the end of the year. In this context, the Bank of Japan will find it increasingly difficult to continue sending dovish signals, as this may further depress the yen. Even if the interest rate is raised to 1%, Japan's policy rate will still be one of the lowest among developed countries. Taro Kimura of Bloomberg Economics said, "As other major central banks turn to rate hikes, interest rate differentials may once again become a key factor driving the yen's depreciation, thereby increasing upward pressures on inflation." At the policy meeting in April, Kuroda faced three opposing votes supporting a rate hike, the largest dissent within the policy board since becoming Governor. Since then, two members who previously voted to maintain rates have publicly stated their support for a rate hike. In his final public speech before the June meeting, Kuroda also hinted at the high likelihood of a rate hike. Kuroda previously stated that the authorities will focus on addressing inflation issues as price risks appear more urgent than downside economic risks. He stated, "Based on the data and information currently available, price upside risks overall appear greater and may manifest more quickly." Investors will also be watching to see if any policy board members oppose the rate hike this time. As the first member nominated by Prime Minister Sanae Takai to join the policy board, Toharo Asada may be more inclined to support a loose policy to reflect the Prime Minister's policy stance. One of the reasons for opposing a rate hike in June is the recent weakening trend in inflation data. Due to government subsidies, current inflation levels are below the Bank of Japan's 2% target. However, the Bank of Japan expects inflation to pick up again later this year as increases in energy costs due to the Middle East conflict gradually transmit to the economy. Kuroda has mentioned that consumer price increases this fiscal year may exceed 3%. Investors also expect inflation to further heat up. Japan's 10-year breakeven inflation rate - an indicator of bond investors' expectations for the average consumer price rise over the next ten years - rose to a record 2.35% last month and has since remained around that level, as rising oil prices and a weak yen together push up inflation pressures.