Fed pauses, Bank of Japan likely to hold steadywhy is funding still unable to breathe easy? December rate-hike suspense weighs on stocks, bonds, and the yen.

Economists widely expect the Bank of Japan to keep its benchmark rate unchanged on Friday, while saying underlying inflation has finally reached and stayed above its 2% anchor over time. That milestone would strengthen the case for further rate hikes. In a recent Bloomberg survey of global economists, all respondents who have long tracked the BOJ's policy path expected the central bank to leave its policy rate unchanged at the end of this week's two-day meeting. The BOJ raised rates to 1.25% last month. As the chart above shows, the BOJ under Kazuo Ueda is still steadily advancing its rate-hike process. A key focus on Friday will be whether the BOJ says underlying inflation has broadly reached its 2% target. That would be the first time since the target was set in 2013, and the outcome looks highly likely. It would reinforce the case for further rate hikes, as Japan's borrowing costs remain relatively low and stimulative. " The BOJ will likely judge that underlying inflation is now around 2%," said Ryutaro Kono, chief Japan economist at BNP Paribas. "The BOJ may see a need to raise rates to a neutral level as soon as reasonably possible, but upside inflation risks are not yet strong enough to force it to hike at two consecutive meetings." The BOJ meeting follows the Federal Reserve's overnight decision to keep its policy settings unchanged. That decision weighed on the dollar and pushed the yen to about 157.84 per dollar in Tokyo on Thursday morning. Although the BOJ has been relatively vague about exactly where underlying inflation stands, multiple indicators have shown for years that inflation is taking root in Japan. In March this year, the BOJ began publishing a new set of price indicators that capture core inflation changes after stripping out factors that are largely temporary. An upgrade to its assessment of underlying inflation would lay the groundwork for another rate hike at the December meeting. More than 80% of surveyed economists expect the central bank to act then. The BOJ's September adjustment to its benchmark rate was its second hike in three months, marking the fastest pace of increases in 36 years. People familiar with the matter told Bloomberg earlier this month that, given current price trends and the central bank's view that rate hikes so far have had a limited impact on the economy, the BOJ may continue raising rates at roughly the same pace. Ueda has increasingly said underlying inflation is "very close" to 2%, seemingly preparing investors for a wording shift in Friday's quarterly outlook report. Earlier this month, he said the BOJ would not allow underlying inflation to rise significantly further from current levels. Acknowledging that underlying inflation has reached the target would focus markets more on how much further rates need to rise before policy is no longer stimulative. The BOJ estimates the neutral rate is between 1.1% and 2.5%, while stressing that it is difficult to pin down precisely. Institutions including JPMorgan Securities and BNP Paribas expect the terminal rate for this cycle to reach 2.5%. The inflation gauge excluding fresh food has been a key indicator for the BOJ. As of March this year, it had exceeded the central bank's target for four consecutive fiscal years; if the BOJ's latest forecasts are accurate, it will be above target for six consecutive fiscal years. Some economists believe the BOJ has been too cautious in acknowledging this shift and risks falling behind the curve on inflation. The chart above shows that Japan's inflation is expected to remain persistently above the BOJ's anchored 2% target. Note: All calculated by fiscal year. "Five or six years is basically enough time for a first-grade elementary school student to enter junior high school," said Seisaku Kameda, a former BOJ economist and now executive economist at Sompo Institute Plus. "If someone claimed that inflation lasting through that entire period still did not count as a trend, it is hard to imagine people would accept that." Recent economic data and early signals ahead of next year's wage negotiations suggest inflationary pressure remains firm. Last month, a BOJ underlying inflation indicator jumped to 3.2%, the highest in three years. After three consecutive years of record-high wage growth, Japan's largest union federation plans to seek larger pay increases in the next round of negotiations, with a deal expected in March. "Early signals from labor and management leaders ahead of next year's annual wage negotiations suggest Japanese wage growth may accelerate in 2027," said Taro Kimura, an economist at Bloomberg Economics. "That could push inflation even higher and increase the risk that the BOJ raises its benchmark rate above the roughly 2% terminal level currently priced by markets." Divisions among the BOJ's nine policy board members over the inflation outlook were already reflected in last month's 7-2 vote. That outcome left the yen weak even after the rate hike. Investors will watch Friday's vote for signs of momentum toward further rate hikes. Reaching this milestone on the price target would mark the payoff of a policy campaign that began in 2013. At the time, the BOJ launched massive monetary easing with the goal of achieving 2% inflation in about two years. In reality, Japan took nearly a decade, and only after the global inflation shock following Russia's invasion of Ukraine, to see a sustained return of price increases. In March 2024, as the BOJ grew more confident that its underlying inflation target was coming into view, it ended the world's last negative interest rate policy and its yield curve control program. Ueda has so far raised rates six times, making him the BOJ governor with the most rate hikes in a single term in at least half a century. In a recent podcast, Hiroshi Nakaso, a former deputy governor who worked at the BOJ for nearly four decades, highlighted this long-awaited economic shift. Previously, after the collapse of Japan's asset bubble in the 1990s, the country experienced the "lost three decades," during which about 200 financial institutions failed. "Japan is back," Nakaso said. "Deflation is finally a thing of the past, and the economy is shifting to an inflation regime." However, reaching the target does not mean inflation has been an unqualified success. Rising prices have come with record corporate profits, nominal gross domestic product and tax revenue, but they have also intensified cost-of-living concerns, especially among Japan's rapidly aging population. Nearly 30% of Japanese are 65 or older, and about 40% of elderly households rely entirely on pensions for income. Nakaso has said he would open a bottle of champagne to celebrate when the central bank achieves its price target. He stressed that even after the BOJ meets the target, the government still needs to formulate a strong growth strategy. "The need for that has not diminished at all," Nakaso said. BOJ's "hawkish pause" ahead: 2% inflation milestone continues to pave the way for further rate hikes The most important potential change at this BOJ meeting is that, while keeping the policy rate at 1.25%, it explicitly acknowledges for the first time that underlying inflation has broadly reached the 2% target, thereby strengthening the policy basis for continuing to exit easing. Underlying inflation here is the central bank's judgment on persistent price trends after stripping out temporary factors, and is not equivalent to a single month's consumer price index. Japan's inflation gauge excluding fresh food has exceeded 2% for years, but the central bank has been waiting for more sufficient evidence of persistence from wages, service prices and corporate pricing behavior. In the Bloomberg survey, all respondents expected a pause this week, and more than 80% of surveyed economists expected a December hike; early signals from wage negotiations mean wage growth in 2027 could still entrench inflation. Therefore, a pause and an upgrade to the inflation assessment can occur at the same time: the former reflects the pace of hikes, while the latter determines the direction of tightening. This change will also shift market focus from "whether there will be a hike this week" to where the terminal rate will ultimately settle. The BOJ estimates the neutral rate range at 1.1%-2.5%, and institutions including JPMorgan Securities and BNP Paribas expect the terminal rate for this cycle to reach 2.5%, above the roughly 2% currently priced by markets. For the yen and Japanese government bonds, what truly has revaluation power is the ultimate rate level and the speed of reaching it: if the central bank confirms that underlying inflation has met the target and retains a relatively fast pace of hikes, short-end yields and the yen will gain policy support; if the number of board members supporting a hike also increases, that signal will be stronger than a pause that is already fully priced. The return of long-term inflation is not without its positive driversrising prices boost corporate nominal income and tax revenue, while also eroding the purchasing power of households dependent on pensions over the long term. Therefore, monetary policy normalization still needs support from productivity and real income growth. On October 28, the Federal Reserve kept the federal funds rate target range at 3.75%-4% by a 10-2 vote; Cook and Hammack both advocated an immediate 25 basis point hike. The Fed's latest monetary policy statement described economic activity as expanding at a "strong pace," emphasizing productivity growth, capital investment and the resilience of domestic spending, while confirming that inflation remains elevated. The key point in Warsh's remarks at the press conference was that: after the September rate hike, financial and credit conditions for some businesses and households had already tightened, but he was still unwilling to define overall conditions as "restrictive." This means that recent increases in financing costs have already played a transmission role, but are not enough to automatically prove that policy needs no further adjustment. He also stressed the need to prevent relative price increases, such as in energy, from spreading throughout the economy and to keep inflation expectations stable. Warsh did not directly equate strong growth with economic overheating. He believes productivity improvements may allow the economy to grow faster without achieving price stability by suppressing activity and increasing unemployment; but he also noted that the observed productivity improvements largely predate the current AI boom and cannot all be attributed to AI. For December, he continued to emphasize the importance of new information and explicitly stated that politics and elections did not play a role in this decision. Markets therefore showed repricing across different maturities: some forward hike bets weakened, but a December hike is still highly priced. A Reuters market close report, citing CME data, said the probability of a 25 basis point hike was about 85%. A pause does not mean the end of tightening! The Fed keeps the hike option open, and the BOJ is likely to follow Warsh announced that among the Fed's eight FOMC monetary policy meetings in 2027, one will be dedicated to discussing broad monetary policy strategy and is not expected to include rate votes or issue policy statements like a traditional FOMC monetary policy meeting; in 2028, two strategy meetings and six policy-setting meetings are expected. In addition, recommendations from the Fed's balance sheet working group under Warsh are expected to be submitted for discussion in early the first quarter of next year; Warsh did not announce any immediate new Fed balance sheet reduction action. For the outlook for global financial market portfolio strategy, pauses by both the U.S. and Japanese central bank systems do not mean financing conditions will loosen in sync: the safe-haven yen exchange rate depends on expected rate differentials between the two countries and capital flow dynamics, while rising Japanese government bond yields may increase the relative appeal of domestic assets. In addition, market focus will immediately shift from "whether there will be a hike this week" to where the terminal rate will ultimately settlethe BOJ estimates the neutral rate range at 1.1%-2.5%, and institutions including JPMorgan Securities and BNP Paribas expect the terminal rate for this cycle to reach 2.5%, above the roughly 2% currently priced by markets. For AI computing power trades, policy affects funding costs through the risk-free rate, corporate credit spreads and exchange rates, while energy prices affect project costs through electricity, transportation and equipment manufacturing; large-model training, continuous inference and the expansion of agent tasks can increase computing power demand, but what ultimately supports valuations is these demands being converted into revenue, profit and cash available for reinvestment. The clearer investment theme at present is to identify, in an environment where rates remain high, companies that can continue to expand through strong AI commercialization growth, technological efficiency and balance sheet strength.