Bank of Japan prepares to declare that underlying inflation has reached its 2% target

Sources told Reuters the central bank could do so in its October 30 outlook report, one month after it raised its policy rate to a 31-year high, while Nidec's yen bonds fell to the lowest price among more than 3,000 local corporate notes.

The Bank of Japan (BOJ) is considering a formal conclusion that Japan's underlying inflation rate has reached about 2%, sources told Reuters. It could state that view as early as October 30, in its quarterly Outlook for Economic Activity and Prices report, which follows a two-day policy meeting starting October 29. The Japan Times reported that recent Tokyo consumer-price data and the BOJ's quarterly tankan business survey (a closely watched gauge of corporate sentiment) have strengthened the board's view. The bank also tracks its own estimates of the output gap (the gap between actual and potential economic output), potential growth and labor-market slack.

The BOJ raised its key rate in September. BOJ Governor Kazuo Ueda said the bank is now focused on keeping underlying inflation from overshooting its target. According to the sources, many officials are cautious about raising rates again in October and want more data on how earlier hikes have affected financial conditions. The declaration would be mostly symbolic. It would support market expectations of a December hike and signal that the bank is prepared to raise rates at short intervals. Government warnings of currency intervention have failed to lift the yen, so some traders still see a chance of an October move. The dollar traded at 158.06 yen on Monday.

Japanese corporate credit is beginning to show strain. Motor maker Nidec's yen bond due in mid-2032 fell to ¥77.7, the Japan Times reported. That is the lowest price among more than 3,000 local corporate notes. The drop follows an accounting scandal and is an early challenge for Nidec's new chief executive.

What this means

For a quarter century, Japan's near-zero rates supplied cheap funding to the rest of the world. Japanese insurers and pensions bought foreign bonds, and investors borrowed in yen to buy higher-yielding assets abroad (the yen carry trade). Each BOJ hike makes domestic bonds more attractive to Japanese savers and raises the cost of that trade. That reduces a steady source of demand for US Treasuries and European government debt just as those markets are selling off. A December hike is already priced. The declaration of reaching 2% is not fully priced, because it would end the case for keeping rates low. In August 2024, a BOJ hike combined with weak US data forced a rapid unwind of yen carry trades, and the Nikkei fell more than 12% in one session. The likelier outcome is that the BOJ makes the declaration on October 30 and the market moves toward pricing two more hikes over the next six months. That would support the yen and keep upward pressure on global long-term yields. The read is wrong if the yen weakens past recent lows after the declaration, which would mean the gap between US and Japanese rates still outweighs the BOJ's signals.

What to watch

The wording of the October 30 outlook report on underlying inflation. A clear statement that 2% has been reached removes the bank's main reason to keep rates low.
Monthly data on Japanese investors' purchases of foreign bonds. Net selling would show capital moving back to Japan.
Further weakness in lower-rated Japanese corporate bonds such as Nidec's. Higher rates are now testing weaker borrowers in a market that has not seen them in decades.

Bank of Japan prepares to declare that underlying inflation has reached its 2% target

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