The upcoming monetary policy meeting of the Bank of Japan (BoJ) on December 21 is garnering significant attentionWhile the market generally expects interest rates to remain unchanged in the short term, expectations for future rate hikes are on the riseA recent Reuters survey indicates that 95% of economists believe the BoJ will raise policy rates within the next three months, a substantial increase from 67% in an October survey.

Current Expectations and Market Sentiment

There is a growing consensus that the likelihood of a rate hike this year has diminished, with many analysts suggesting that the central bank's actions may be postponed until JanuaryJPMorgan has cautioned that if the BoJ surprises the market with a rate increase in December, the Japanese yen could experience significant volatility, with initial declines against the U.Sdollar potentially ranging from 1% to 2%, which could exceed the drop seen during last July's rate hike.

Bank of America, on the other hand, posits that the BoJ may delay any hikes until March

In a report, Bank of America highlighted that while Japan's economic data shows some positive signs—such as a slight improvement in manufacturing confidence—the overall economy remains in a recovery phaseThe business confidence index among major manufacturers has shown a modest uptick, largely driven by improvements in the automotive and machinery sectorsHowever, the electrical machinery sector has struggled due to a slowdown in the technology cycle.

Labor Market Challenges

Japan's businesses are facing significant labor shortages, which could hinder planned capital expenditure increases of 10% in the 2024 fiscal yearRising labor costs combined with these shortages may restrict companies' ability to fully realize their capital spending plansGiven the easing of inflation pressures and uncertainties surrounding the global economic outlook, the possibility of a year-end rate hike appears low.

Nevertheless, as Japan's economy gradually regains momentum, expectations are building for the BoJ to take action in January to address potential inflationary pressures

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JPMorgan's latest report notes that despite the cooling expectations for a rate hike this month, the possibility of an unexpected hike remainsThe report emphasizes that statements from BoJ officials suggest a continued inclination to raise rates, maintaining the forecast for a December hike.

Volatility and Market Reactions

If the BoJ were to implement an unexpected rate increase, the dollar-yen exchange rate could experience significant downward movement, potentially falling by 1% to 2%. Such a scenario would be particularly noteworthy given the current low expectations of a rate hike in the marketCompared to the environment in July, the current market conditions feature fewer speculative short positions against the yen, and it is unlikely that the BoJ Governor will issue overly hawkish statements.

Bank of America suggests that while a policy shift may occur in January, there is also the possibility that it could be pushed to March

In assessing the statements from the BoJ Governor, it appears that, while economic indicators are improving, global economic uncertainties and concerns over sustained wage growth are leading the central bank to adopt a cautious approach regarding rate hikes.

Future Projections

Looking ahead, it is anticipated that the BoJ may increase rates by 25 basis points to 0.5% in January 2025, with further hikes expected in July 2025 and January 2026. However, there remains skepticism in the market regarding whether the BoJ will proceed with a January hike or delay it until MarchBank of America points out that the probability of a January hike appears more favorable, as the central bank may need additional time to gather feedback from businesses to assess the inflation landscape comprehensivelyThe latest business feedback is expected to be available only in January.

Moreover, January coincides with the BoJ's publication of its "Outlook Report," providing an opportune moment to convey policy intentions

Additionally, given the typically lower liquidity in the market at year-end, a December rate hike could spark market volatility, making a January hike a more prudent option from a risk management perspective.

However, delaying the rate hike too long could pose risksTraders have warned that if the BoJ fails to raise rates in January, it could lead to doubts about the central bank's commitment to tightening policy, potentially pushing the yen back toward the 150 levelBank of America cautions that if the BoJ postpones the hike to March, the topic of arbitrage trading may resurface, leading to a depreciation of the yen to around 155 or slightly below the 157 level reached in November.

Conclusion

The upcoming BoJ meeting is critical, as the decisions made will not only affect Japan's economic landscape but also have wider implications for global marketsWith economists increasingly expecting a rate hike in early 2024, the potential for increased volatility in the yen and shifts in investor sentiment is palpable