Bank of Japan shifts to an "anti-inflation" mode! Kazuo Ueda hints there is still room for rate hikes, with December action in focus.

The Bank of Japan kept its policy rate unchanged at 1.25% on Friday, but Governor Kazuo Ueda's remarks at the post-meeting press conference sent a policy signal more noteworthy than the rate decision itself. With underlying inflation having reached a level broadly consistent with the 2% target, the BOJ's policy focus is shifting from pushing prices higher to preventing inflation from deviating from target. Ueda made clear that the central bank will not sit back and wait for inflation expectations to anchor naturally, but will adjust policy in a timely manner based on economic, price and financial conditions. In other words, the BOJ's phase of chasing the 2% inflation target is drawing to a close, and monetary policy normalization is entering a new stage. The most intriguing part of Ueda's remarks was his explanation of the boundary between "the target has been reached" and "the target has not yet been achieved." He said Japan's underlying inflation has reached a level consistent with the price target, but the BOJ seeks to achieve the 2% inflation target sustainably and stably, and "in that sense, we have not yet reached the target." This does not mean the central bank will continue to wait passively, but rather that it needs to anchor underlying inflation firmly around 2% through appropriate monetary policy adjustments. This formulation reflects a change in the BOJ's policy reaction function. In the past, the BOJ long worried about insufficient inflation, with policy focused on escaping deflation and driving a sustained rise in prices; now, with underlying inflation approaching target, the central bank is placing greater emphasis on whether inflation expectations can stabilize around 2%, and whether rising energy and raw material prices will push prices further higher. Ueda specifically noted that Japan's inflation expectations have in fact not yet fully anchored near the target. The central bank will continue to monitor multiple indicators, but more importantly will judge the mechanisms behind price changes, especially whether medium- to long-term inflation expectations have stabilized near the target level. He also stressed that once underlying inflation reaches 2%, a significant overshoot of prices is undesirable, so the central bank must respond appropriately to upside risks. The hawkish implication of these remarks is that the BOJ no longer needs to wait for inflation to rise further markedly before considering tightening. As long as underlying inflation is near target, financial conditions remain accommodative, and upside risks persist, there is a stronger case for further rate adjustments. **Behind "will not sit back and wait": the pace of hikes depends on data and cumulative effects** On the next policy path, Ueda did not give a clear timetable for rate hikes, but he also did not give the market a reason to wait with confidence. He said the pace of future rate hikes will depend to a large extent on upcoming data, and the BOJ cannot pre-determine how many months need to elapse between each hike. At each policy meeting, the central bank will comprehensively assess the likelihood that the baseline economic and price outlook will be realized, as well as related risks. This means the BOJ does not intend to raise rates mechanically on a fixed timetable, but it also does not rule out acting every few months. Ueda stressed that the central bank needs to assess both the risk of an overshoot in underlying inflation and just how accommodative current financial conditions are. On the neutral rate of interest that the market is watching, Ueda acknowledged that it is not easy to judge when the policy rate will reach the neutral level. The central bank needs to examine the cumulative impact of past rate hikes, because current financial conditions may not fully reflect all the effects of previous rate adjustments. He said the BOJ still needs to narrow the gap between the policy rate and the neutral rate, and gradually adjust the degree of monetary accommodation. This also explains why the BOJ did not raise rates again at this meeting. The central bank wants to further observe the cumulative impact of previous hikes on lending conditions, economic activity and prices, rather than acting immediately simply because underlying inflation has reached 2%. The meeting ultimately decided to keep rates unchanged by an 8-1 vote. Hawkish board member Takata Hajime opposed standing pat and advocated raising the policy rate to 1.5%. This divergence also shows that voices calling for faster policy normalization have already emerged within the decision-making body. **Energy costs transmitting to consumers; wage negotiations remain a key variable** Ueda's assessment of inflation risks also leaves room for future rate hikes. He noted that the Middle East conflict has pushed up energy and raw material costs, and the related pressure had already been clearly reflected in inter-company prices, while September and October data began to show these upward pressures spreading further to consumer prices. As cost pressures transmit to the consumer side, underlying inflation may also be pushed higher. However, what the BOJ needs to judge is not only the short-term price shock from higher energy prices, but also whether these price changes can form a more persistent inflation mechanism through wages, service prices and inflation expectations. In Ueda's view, for underlying inflation to anchor stably at 2%, wage negotiations between companies and unions need to proceed on the premise that future inflation will run near 2%. He noted that average consumer inflation this year may be around 2% or slightly lower, and the central bank needs to observe how this affects next year's spring wage negotiations. Whether wage growth can be sustained is an important basis for the BOJ to judge whether inflation truly has endogenous momentum. If companies continue to raise wages and pass labor costs through to goods and service prices, Japan may form a more stable wage-price cycle; conversely, if price increases are driven mainly by energy and import costs, the sustainability of inflation remains uncertain. The quarterly outlook report released by the BOJ on Friday also reflects the emphasis on price risks. The central bank raised its forecast for core CPI growth in the fiscal year ending March 2028 to 2.6% from 2.4% previously, and said long-term inflation expectations are fluctuating around 2%. The report also noted that Japan's economy is expected to grow moderately, but the Middle East situation and rising energy costs still pose uncertainties. **December rate-hike expectations build; JGB market begins searching for a new pricing anchor** Ueda's remarks further strengthened market expectations that the BOJ will raise rates again within the year. A Reuters survey of economists showed that among respondents expecting a BOJ rate hike in the fourth quarter this year, about 80% believed action could come in December. Citi, MUFG and other institutions also point to December or January next year for the next hike. However, policy expectations for short-end rates and long-end JGB yields do not entirely follow the same logic. The short end more directly reflects the market's judgment on the BOJ's next rate move; the long end is simultaneously affected by the future rate path, inflation expectations, JGB supply and term premiums. The yield on 30-year JGBs rose at one point in October to a record high of about 4.25%, then fell back. As of October 30, the yield had fallen to about 3.84%. The retreat of long-end yields from highs reflects changing market pricing of JGBs, but it does not mean investors are no longer worried about BOJ rate hikes. In fact, some global asset managers have recently begun to rebuild JGB exposure. Bloomberg reported that Allianz Global Investors is selectively adding to medium- and long-end JGBs, while BNP Paribas Asset Management has raised its 20-year and 30-year JGB positions from "very small scale" at the start of the year to "medium scale." T. Rowe Price has also shifted to preferring longer-dated JGBs. Among them, some flexible strategies at BNP Paribas Asset Management have adopted a combination of long 20-year and 30-year JGBs and short 2-year and 5-year JGBs, betting on a flattening of the yield curve. Such trades are not bets that the BOJ will stop raising rates, but rather that short-end rates may still be driven by policy normalization, while the long end may benefit from allocation demand generated by previously high yields and from the market's reassessment of the future rate path. Therefore, the core question in the JGB market is expanding from "when will the BOJ continue raising rates" to "where will rate normalization ultimately end." If investors gradually form a judgment on the endpoint of tightening, long-end yields may not necessarily rise in tandem every time short-end rate-hike expectations heat up. **From rate normalization to balance-sheet adjustment: the BOJ further exits the era of easing** In addition to Ueda's remarks, the BOJ also announced on Friday that it will accelerate the pace of selling its exchange-traded fund (ETF) holdings. From January 2027, the central bank will increase its annual ETF sales from about 330 billion currently to about 860 billion (on a book-value basis). At the new sales pace, the BOJ estimates it will take about 43 years to complete the disposal of the relevant holdings, significantly shorter than the previous estimate of 112 years. Although the process will still be very long, the increase in sales scale means the BOJ is further adjusting the assets accumulated during the past era of large-scale monetary easing. This decision echoes the changes in interest rate policy: the BOJ not only needs to gradually raise the policy rate, but is also slowly exiting the unconventional easing measures implemented over the long term. However, the actual impact of ETF sales on the market still needs to be observed in light of the sales pace, market trading volume and investors' capacity to absorb them, and it should not be simply understood as a large-scale sell-off shock in the short term. For the yen, the BOJ's clearer emphasis on upside inflation risks and its retention of room for further rate hikes should in theory help limit further widening of the Japan-US interest rate differential and provide some support for the yen. But the yen's trajectory still depends on the Federal Reserve's policy path and changes in US Treasury yields, and the BOJ's hawkish rhetoric alone is not enough to judge that the yen will enter a sustained appreciation cycle. For global bond markets, changes in Japanese long-end yields are also worth watching. Rising JGB yields may increase the appeal of Japanese domestic assets to local institutions, thereby affecting Japanese investors' willingness to allocate to overseas assets such as US and European bonds. However, actual capital flows also depend on currency hedging costs, overseas bond yields and institutional liability structures, and cannot be inferred from a single BOJ policy meeting alone. Overall, the BOJ's decision to keep rates unchanged on Friday does not mean its policy stance is turning cautious or shifting toward easing. The real message from Kazuo Ueda's remarks is that when underlying inflation has reached a level consistent with the 2% target, the central bank's focus must shift from pushing inflation higher to preventing an overshoot. The BOJ still needs to observe wage growth, inflation expectations and the cumulative impact of previous rate hikes, but the direction of further policy tightening is already quite clear. For the market, the next rate hike may come in December, but more important than the specific date is that the BOJ is gradually clarifying the objectives and boundaries of monetary policy normalization. Japanese bonds, the yen and global capital allocation will all be repriced around this new policy framework.