• Bank of Japan's (BoJ) surprised the market with a 15 basis points (bps) hike in its overnight call rate (OCR) and announced plans to taper its bond- buying program. This decision reflects the BoJ’sexpectation that wage increases will continue tospread, putting upward pressure on inflation.

• 7-2 majority vote on the short-term interest rate:The bank increased the OCR by 15 bps, setting the rateat 0.25% for current account balances held by financialinstitutions at the Bank.

• Unanimous vote on long-term interest rate: Votingcommittee unanimously agreed to reduce its monthlypurchases of Japanese government bonds (JGB) toapproximately JPY3.0t in 1Q26, down from the currentJPY6.0t. The reduction will proceed at a pace of aboutJPY400.0b each calendar quarter. However, the BoJmay increase JGB purchases if there is a rapid rise inlong-term interest rates.

• Guidelines for asset purchases (unanimous vote): To gradually reduce and ultimately halt the purchase ofcommercial paper and corporate bonds within one year.

• BoJ growth and inflation outlook: Japan’s economy is poised to surpass its potential growth rate, propelled by avirtuous cycle of income and spending, supported by accommodative financial conditions. Inflation is expected to exceedprevious forecasts through fiscal 2025, fuelled by narrowing output gaps and rising medium- to long-term inflationexpectations as the wage-price spiral intensifies. However, this positive outlook is tempered by significant risks, includingglobal economic uncertainties, fluctuating commodity prices, and domestic wage and price-setting behaviours.

• Sustained wage growth and rising inflation likely to drive BoJ rate hike in 4Q24
  
  − The primary driver behind today’s decision, aside from the BoJ's confidence in a continued cycle of rising wagesand inflation, appears to be the excessive weakness of the yen. Governor Kazuo Ueda's post-meeting commentswere notably hawkish, emphasising the spread of wage hikes and rising service prices, which could prompt furtherrate increases, especially if the economy and prices align with the BoJ's projections. Given the elevateduncertainty, the BoJ is likely to first assess the impact of rate hike on the economy before potentially raising ratesby another 15 bps in 4Q24.
  
  − USDJPY year-end forecast (145.70; 2023: 141.04): Despite some disappointment over the scale of bond purchasetapering, prospects of higher wage growth and improving consumption may sustain market expectations foranother rate hike this year, potentially strengthening the yen. However, gains may be limited due to lingeringconcerns about weak economic growth. This outlook is also contingent on incoming US macro data. We anticipatecontinued weakening in the US economy, with a September rate cut almost certain, favouring the JPY.Nonetheless, downside risks from political and geopolitical uncertainties may still exert pressure on the yen.

Source: Kenanga Research - 2 Aug 2024