Bank of Japan's "hawkish pause" materializes! Underlying inflation hitting target paves the way for a return to rate hikes in December, and the yen regains its safe-haven appeal amid the AI selloff.

The Bank of Japan, as expected by the market during Asian midday trading on Friday, followed the Federal Reserve and the European Central Bank in keeping its benchmark interest rate unchanged, while stating in its official monetary policy statement for the first time that underlying inflation has reached the 2% target. This milestone effectively opens the door for a return to rate hikes as early as December and for the future normalization of the policy rate path. According to the BOJ statement, the central bank kept its policy rate at 1.25% at the two-day meeting ending Friday. All economists surveyed by major financial institutions had predicted this hold. Achieving the inflation target means the BOJ now needs to shift from pushing inflation higher to ensuring inflation does not overshoot the target. The BOJ said it is "crucial" to keep inflation near the current level going forward, while warning that underlying inflation risks deviating upward from the target. Given the upside inflation risks, more than 80% of surveyed economists expect the BOJ to raise rates again in December. As shown in the chart above, most veteran BOJ watchers now expect the BOJ to raise rates again in December. Junya Takemoto, senior economist at Sumitomo Mitsui Banking Corporation, said: "At Ueda's press conference this afternoon, given that market expectations for a December rate hike are already so strong, I want to see whether the BOJ reinforces those expectations or maintains a neutral stance. In the past, Ueda has said at press conferences that the BOJ will closely assess developments before the next meeting." The BOJ also said it will, starting in January, increase the pace of selling its holdings of exchange-traded funds to nearly triple the previous rate, expecting to sell about JPY860 billion (approximately US$5.5 billion) per year. The bank said completing this process will take about 43 years, compared with more than 110 years at the previous selling pace. The yen appreciated from 157.52 per dollar before the decision to about 157.12 per dollar. Market focus now shifts to Governor Kazuo Ueda's press conference scheduled for around 3:30 p.m. local time. Investors will closely look for guidance on the next rate hike and any clues on how high rates will ultimately rise in this tightening cycle. The BOJ was the last of the three major central banks meeting this week to announce its decision, with the Fed and ECB also holding rates steady. Last month, all three raised rates in unison for the first time. For the BOJ, back-to-back rate hikes at consecutive meetings would be an unprecedented move this century and could spook markets. Japan's benchmark rate is already at its highest level in 31 years, though still low compared with other G7 members. The BOJ monetary policy statement showed the rate decision was passed by an 8-1 vote, with Takata Hajime dissenting in favor of a rate hike. The BOJ raised borrowing costs again on September 18, three months after its June hike, marking the shortest interval between rate increases since 1990. After the BOJ held rates steady, the yen quickly extended gains against the dollar. After the BOJ held rates as expected and said for the first time that underlying inflation had reached 2%, the yen extended its advance against the dollar. After BOJ monetary policy committee members voted 8-1 to keep rates unchanged, the yen rose as much as 0.4% to 157.12 per dollar. All 53 Japan economists surveyed by Bloomberg had expected the BOJ to make this decision. The move came as global markets shifted toward safe-haven assets on Friday, with tech stocks falling and oil prices rising. The yen has already shown signs of recovering its traditional safe-haven role. For years previously, during periods of market stress, large interest rate differentials and Japan's massive overseas investment flows had a greater impact on the yen than safe-haven demand. As shown in the chart above, after the BOJ decision was announced, the yen rapidly extended gains against the dollar, highlighting the pace of yen appreciation. OCBC currency strategist Moh Siong Sim said the central bank's confirmation that the official inflation target has been achieved "sends a signal of further policy tightening ahead" and "should support the yen." However, "the risk of renewed US-Iran tensions after the US midterm elections has already pushed up oil prices, which may prevent the yen from fully benefiting from the weaker dollar environment caused by AI concerns." Goldman Sachs strategists previously said that as Japan's policy environment changes, the risk of sharp yen weakness when global yields rise has diminished, and the yen is becoming a more effective tool for hedging against AI-induced market shocks. Last week, a global tech stock selloff boosted demand for safe-haven assets, and the yen rose to its strongest level in more than a month against the dollar, reaching 156.08 per dollar. Meanwhile, long-term Japanese government bonds have recently performed strongly, with signs of recovering domestic demand and a more favorable policy environment further enhancing the appeal of higher yields. The 30-year JGB yield has fallen about 40 basis points from its peak of 4.25% earlier this month. The BOJ said it will, starting in January, increase the annual pace of ETF sales from about JPY330 billion to about JPY860 billion, after which Nikkei index futures in the Osaka market extended losses. Japanese stocks also came under pressure alongside other global markets as concerns about AI-related spending and valuations triggered a tech selloff. Shogo Karitani, strategist at a Hong Kong bank, said: "The ETF selling arrangement was unexpected. This is seen as a strongly hawkish move by the BOJ because it represents further progress in monetary policy normalization, which drove some modest yen buying." As the scale of AI infrastructure-related bond issuance by global tech companies continues to surge, pushing overall tech company bond issuance to a record high this year, yield indicators in the global credit bond market have continued to deteriorate, driving up AI-related financing costs and overall financing costs for Japanese companies significantly, with credit spreads broadly widening. Traders will focus on BOJ Governor Kazuo Ueda's post-decision press conference, which typically begins at 3:30 p.m. Tokyo time. The real change in the "hawkish pause": official inflation assessment crosses a major threshold, ETF exit unexpectedly accelerates The core change in this BOJ decision is that holding rates and advancing policy normalization occurred simultaneously. On October 30, the central bank voted 8-1 to keep the policy rate at 1.25%, in line with all 53 economists surveyed by Bloomberg; Takata Hajime advocated a 25 basis point hike to 1.5%. The rate decision itself created no surprise. The incremental information that truly affected market pricing was the central bank's first confirmation that underlying inflation is now broadly consistent with the 2% target, and its announcement to accelerate the sale of equity ETFs. After the decision, the yen's gain against the dollar briefly widened to about 0.4%, reaching 157.12, while Nikkei index futures extended losses. "Underlying inflation meeting the target" means the BOJ's assessment of persistent price trends has changed. The mutual reinforcement between wages and prices and the stabilization of medium- to long-term inflation expectations have shifted the policy focus further toward preventing inflation overshooting. The official outlook raised the fiscal 2027 CPI forecast excluding fresh food from 2.4% to 2.6%, while lowering the real GDP growth forecast for the same period from 0.8% to 0.7%, presenting a combination of moderate growth and still-strong price pressures. The central bank explicitly retained the direction of further rate hikes depending on economic, price and financial conditions, making December the next window of market attention; more than 80% of surveyed economists expect a hike then, but this is not a commitment by the central bank to a specific meeting. The acceleration of ETF reductions reinforced the signal of exiting unconventional easing. Official documents show that from January 2027, the annual selling amount, calculated at book value, will increase from about JPY330 billion to JPY860 billion, about 2.61 times the original; the corresponding estimated market value is about JPY2.46 trillion. Based on current holdings and the reduced pace, the time needed to complete disposal will be shortened from about 112 years to 43 years. This distinction will directly affect judgments about market supply pressurenamely, that JPY860 billion is on a book-value basis, not expected cash proceeds from sales. This arrangement will increase the supply of equity assets that private investors need to absorb and reinforce the policy signal that the central bank is exiting risk asset holdings, so it can simultaneously pressure Japanese stocks and support the yen. However, official estimates put the selling amount at about 0.1% of stock market turnover, and the BOJ retains room to adjust or suspend sales depending on market conditions, indicating that normalization remains gradual. The weakness in Nikkei futures also occurred against the backdrop of global pressure on AI tech stocks, and investors did not attribute it entirely to the ETF reduction measure. Why can the yen and long-term bonds rise simultaneously? The "safe-haven trade theme" triggered by the collapsing AI trade is reshaping spreads and capital flows The yen is gaining support from both domestic policy and global safe-haven demand. The BOJ maintaining its direction of further rate hikes helps improve the relative interest rate outlook for yen assets; concerns about AI investment returns pushing up US Treasuries and lowering yields may weaken the yield advantage of dollar assets. If risk asset adjustments are accompanied by unwinding of yen-funded carry trades, with investors buying back yen to repay financing, this could further strengthen appreciation pressure. On this basis, Goldman Sachs believes that compared with the past few years, the yen is becoming a more effective hedge against AI market shocks: Japan's policy normalization reduces the extent to which the yen persistently faces one-sided depreciation pressure when overseas yields rise, and an environment in which US stocks and US Treasury yields decline together is usually more favorable for yen performance. However, the yen may perform differently in hedging AI growth shocks versus energy supply shocks. The former often comes with falling US Treasury yields and shrinking risk positions; the latter may raise Japan's energy import bill and worsen its terms of trade, while also prolonging the period of high US rates. OCBC strategists emphasized in an updated report that potential escalation of US-Iran tensions pushing up oil prices may limit the yen's gains from dollar weakness. Therefore, the key to current yen strength is the combined effect of policy normalization and safe-haven demand, while oil prices and incremental safe-haven flows from a large-scale AI trade collapse are important variables affecting the magnitude of appreciation. The rise in long-term JGBs can also coexist with a "hawkish pause." The 30-year JGB yield has fallen about 40 basis points from this month's high of 4.25% to about 3.85%. Long-term yields reflect the future path of short-term rates and the term premium: expectations of further rate hikes may push the former higher, but more credible inflation control, allocation demand from long-term funds such as insurance institutions, and global safe-haven buying can the risk compensation required for long-term bonds. As a result, the short end remains constrained by rate hike expectations, while the long end may rise, and the yield curve may flatten. This dynamic reflects pricing differences across maturities. The BOJ's latest outlook itself reveals this set of market tensions: the expansion of AI applications and related fixed investment can continue to support the global economy, but if profit growth cannot keep pace with investment expansion, asset prices may face adjustmentthat is, the AI trade completely collapses and the AI bubble fully bursts; at the same time, rising prices of semiconductors, copper and machinery may pass through to consumer prices. In other words, AI can simultaneously be a supporting factor for real investment and inflation, and a trigger for financial markets to reassess valuation and financing risks. This is the common backdrop for the central bank to continue focusing on rate hikes while investors buy long-term government bonds for safe-haven purposes. For the global bond market, the short-term dominant force remains safe-haven demand. Pressure on tech stocks can simultaneously push up US Treasuries, long-term JGBs and the yen; Bloomberg's earlier report that US Treasuries returned about 2% in October and the benchmark yield fell nearly 40 basis points in total reflects this round of capital flows. In the medium term, improving domestic yields in Japan may increase the appeal of Japanese bonds, but rising short-term Japanese rates may also narrow the Japan-US rate differential and reduce the currency hedging cost for Japanese funds holding dollar bonds, so one cannot mechanically conclude that "Japan's normalization will inevitably trigger a selloff in US Treasuries." Actual allocation depends on hedged returns, exchange rate expectations and liability matching needs. For the financing environment of the AI supply chain, this distinction is especially important: falling government bond yields help lower the benchmark cost of financing, but widening corporate credit spreads may still offset this benefit. The safe-haven buying of the yen and government bonds first shows that investors are reallocating risk, and does not mean that financing conditions for new cloud companies, tech giants or Japanese companies have already eased in tandem.