With the benchmark interest rate rising to a 30-year high, the direction of the Bank of Japan's monetary policy is becoming the focus of the market. Currently, the transmission effect of the continued weakness of the yen on domestic inflation is becoming increasingly prominent. Coupled with the market fluctuations caused by the prime minister's early election, the Bank of Japan is facing the policy weigh of "whether to raise interest rates in advance." Although the outside world is generally expected to keep interest rates unchanged at the policy meeting on January 23, the trend of the yen, inflation trends and economic recovery progress are jointly determining the time window for the next round of interest rate hikes.

Election rumors roil markets

Japanese Prime Minister Sanae Takaichi's early election plan has added new uncertainty to monetary policy. The prime minister, who is known for his "dovish" stance, has emphasized his preference for low interest rates since taking office in October last year, and his advisory team has repeatedly warned of the risks of further raising interest rates. Market news shows that Takaichi Sanae plans to dissolve parliament next week to prepare for a national vote. This will be the first time she has led an election since taking office. Election rumors have caused significant volatility in financial markets. This week, investors expected that if Takaichi Sanae wins the election, it may promote more expansionary fiscal measures. This expectation has led to a surge in Japanese stocks and pressure on bonds and the yen exchange rate.

The yen exchange rate once fell to its weakest level since July 2024, when Japanese financial authorities used exchange rate intervention to support the yen. Faced with the market shock caused by the election, Bank of Japan Governor Kazuo Ueda released a clear policy signal, emphasizing that the central bank will not deviate from the path of raising interest rates. He said at the New Year's meeting of the Tokyo Regional Banks Association that if the economic and inflation outlook is realized, the central bank will continue to raise interest rates and adjust the degree of monetary easing according to the situation.

Ueda Kazuo also pointed out that wages and inflation are likely to continue to gradually rise, and appropriate adjustments to monetary easing policies will help achieve the goal of price stability and long-term economic growth. Kazuo Ueda's statement is consistent with his previous stance, and also confirms the policy logic of the Bank of Japan: the core anchor of monetary policy is economic and inflation data, rather than short-term political and market fluctuations. He also confirmed that Japan's economy will maintain a moderate recovery in 2025, which will provide fundamental support for subsequent interest rate increases.

Weak yen becomes key variable

The Bank of Japan raised its benchmark interest rate to 0.75% just last month, the highest level since 1995. According to multiple people familiar with the matter, central bank officials prefer to keep the interest rate unchanged at the January policy meeting. The committee plans to monitor economic data and financial market developments up to the last moment before making a final decision. However, the weakness of the yen is becoming a core consideration affecting the path of future interest rate hikes. Officials believe the yen's depreciation is boosting inflation as companies increasingly pass on higher import costs to consumers.

This impact has led some officials to suggest that it is necessary to start the next round of interest rate hikes in advance, rather than follow the pace of "one interest rate hike every six months" generally expected by private economists. In fact, the yen exchange rate has fallen into a long-term weak range. Since the interest rate hike was implemented in December last year, the yen has not strengthened against the US dollar. Instead, it fell to an 18-month low due to the news that Prime Minister Sanae Takaichi planned to hold an early election. Even with repeated warnings from monetary authorities, the yen-dollar exchange rate is still fluctuating between 140 and 161.95, a sharp deviation from the ten-year average of 123.20.

The impact of the weakening yen is two-sided: on the one hand, it pushes up import costs and intensifies domestic inflationary pressure; on the other hand, it boosts the profits of exporters. But currently, the inflation transmission effect is obviously more concerned by the central bank. Yoshinobu Tsutsui, head of Japan's largest business lobby group Keidanren, has made a rare statement, calling on the government to prevent excessive depreciation of the yen through exchange rate intervention, bluntly saying that the recent weakening of the exchange rate is "a bit too much."

Interest rate hike in summer becomes mainstream judgment

Economists and market institutions have formed relatively clear expectations for the next time the Bank of Japan will raise interest rates. A monthly Reuters poll showed that 65 out of 67 economists believed the Bank of Japan would keep interest rates unchanged at its two meetings in January and March. Most respondents regard summer as a key window for raising interest rates. Among the 37 economists who specified the specific month for interest rate hikes, 43% preferred July, and 27% believed June. Together, they constitute the mainstream judgment of "summer interest rate hikes."

Economists at Mizuho Securities and Sumitomo Mitsui Trust Bank believe that the central bank needs time to evaluate the effect of raising interest rates, which points to the summer window for raising interest rates, in which the July meeting can be combined with the "Outlook Report" to provide favorable conditions. Market expectations for interest rate hikes have been revised upwards, with more than 75% of respondents expecting the benchmark interest rate to rise to 1% or above in September this year, with some expecting it to rise to 1.25%. The median forecast for interest rates at the end of the year is 1.00%, and 24% of economists expect it to rise to 1.25%. The median expected terminal interest rate jumped to 1.5%, far exceeding the 1% a year ago, with a range of 1%-2%. In terms of the frequency of interest rate hikes, 60% of economists expect to raise interest rates once this year, and 31% think twice. Slightly more than half of the respondents believe that the central bank's pace of curbing inflation "has neither a low nor a high risk of lagging behind the situation," highlighting the difficulty of balancing policies.

Policy decisions under the intersection of multiple factors

Currently, the Bank of Japan is at a crossroads in policy decisions. On the one hand, the inflationary pressure caused by the weak yen continues to heat up, and the trend of corporate cost transfer is clear, and the central bank has practical reasons to raise interest rates in advance; on the other hand, the benchmark interest rate is already at a historically high level, and it takes time to evaluate the policy effects of previous interest rate hikes, and market fluctuations caused by the prime minister's election also need to be dealt with cautiously. Judging from signals from all parties, the Bank of Japan will maintain policy stability in the short term, and it is a foregone conclusion that the January meeting will remain unchanged. But as summer approaches, the combination of the yen's trend, inflation data and the progress of economic recovery will ultimately determine the specific timing of the next round of interest rate hikes. In the context of the world's major central banks turning to interest rate cuts, the pace of interest rate hikes by the Bank of Japan is not only related to the country's price and growth balance, but will also have a profound impact on global capital flows and exchange rate patterns.