MUFG preview: BoJ holds rates, signals 2% inflation, faces dissent risk

If the BoJ holds rates while declaring underlying inflation at 2% and Governor Ueda takes a firm stance, the yen could benefit and December hike expectations might move earlier, lifting short-term JGB yields.

The asymmetric risk is the vote: if the two reflationist members who opposed the last hike now call for a cut, the dovish message could outweigh the hawkish language and spark yen selling. The USD/JPY rate is also exposed to the Fed's meeting this week. A surprising US rate increase that sends the pair sharply higher would be the kind of emergency that, according to the Nikkei report, could put a back-to-back BoJ move on the table. Oil-led inflation from the Iran conflict also supports a more hawkish BoJ stance.

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The Bank of Japan is expected to keep its interest rates unchanged this week but take a major rhetorical step, unless two dovish board members seize the spotlight and the yen suffers.

Summary:

• MUFG predicts the BoJ will hold rates on Oct 29-30, with back-to-back hikes considered only in a serious emergency, per a Nikkei report citing a senior official.
• The revised Outlook Report likely will effectively claim underlying inflation has hit the 2% target, a fresh step for policy normalisation under Ueda.
• After the G20 meeting, Ueda said underlying inflation is roughly near 2% and the BoJ could not tolerate a further rise.
• MUFG sees a fairly hawkish tone from Ueda's post-meeting press conference.
• The key danger: the two who voted against September's hike might oppose a hold and advocate a cut, likely causing yen selling.
• US Treasury Under Secretary Erin Browne reportedly stated Japan's deflationary environment is over and policy should adjust.

The BoJ's October 29-30 meeting probably will not produce a rate increase, but it might be a watershed in how the central bank characterises inflation, according to a MUFG forecast. MUFG predicts the revised Outlook Report will essentially state that underlying inflation has hit the 2% target, advancing the policy normalisation under Governor Ueda.

Consecutive rate increases appear unlikely. MUFG pointed to a Nikkei report quoting a senior BoJ official that the bank would only entertain back-to-back hikes in a serious emergency. MUFG said that could theoretically involve a sharp USD/JPY climb after an unforeseen Fed rate increase, but it considers that situation improbable. The BoJ moved its policy rate to 1.25% in September.

Governor Ueda has been preparing for a stronger stance. After the G20 meeting, he said underlying inflation is now roughly near 2% and that the BoJ could not accept a further increase. This followed his comment after the September meeting that the policy context had shifted, emphasizing the bank's increased focus on inflation control. MUFG thus expects Ueda's post-meeting press conference to be fairly hawkish.

Outside factors align with this view. Over the weekend, US Treasury Under Secretary Erin Browne was reported as saying Japan's deflationary period is over and its monetary policy needs to adapt.

MUFG's primary warning is an internal board risk. The two members who opposed September's hike could dissent again, now objecting to a hold and proposing a cut. MUFG said that from the reflationist members, such action would strengthen the bank's dovish reputation and probably lead to yen selling, weakening the hawkish signals from the Outlook Report and Ueda's press conference.

For investors, the result of the week may thus rely more on the division of the vote and the phrasing regarding underlying inflation than on the rate decision itself.