Bank of Japan: Hawkish path with FX doubts – TD Securities

TD Securities’ Prashant Newnaha notes the Bank of Japan raised its cash rate by 25bps to 1.25%, in line with market expectations, and kept a hawkish framework that points to further hikes, with the next move seen in December. While JGB yields are slightly lower, the Japanese Yen has underperformed as markets focus on Board divisions and potential policy paralysis in 2027.

Hawkish hikes but Yen underperforms

"The BoJ delivered a 25bps hike to 1.25% as was widely anticipated. While there is no smoking gun for a back to back hike in October, today's Statement validates the hawkish July framework with more hikes to come - we expect the next one in December. Yields are a touch lower but the JPY has underperformed sharply with the potential for policy paralysis in 2027 the likely driver."

"“This provides strong justification for additional hikes. Further it reaffirmed the case for 25bps increases in the cash rate roughly every quarter, validating the hawkish July framework, stating: ‘Japan's economic activity and prices have been developing generally in line with the baseline scenario presented in the July 2026 Outlook...’”

"Perhaps the market's focus beyond the immediate Board divisions is the risk that it leads to possible policy paralysis in 2027. In our BoJ note last week we cited downside risks to our 2.25% terminal rate forecast. In particular, we drew attention to Takata and Tamura, the two hawks on the Board both having their terms expiring in July next year."

"If the market perceives these two hawkish Board members are likely to be replaced with appointees sympathetic to the Takaichi administration, this would skew the Board less hawkish/ more dovish than it currently is. While rate markets are little changed to slightly lower in yield, it's the FX market that is casting its vote on the future Board's credibility."

"As we detailed last week's note, the Japanese economy is operating beyond its potential, company profits are booming, and the labour market is likely to strengthen into next year's wage negotiations. The case for hiking towards neutral is simple and the BoJ knows it - the mind is willing, but the FX market is calling the spirit to be weak."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)