ING analysts discussed the Bank of Japan’s recent 25 basis point rate hike and the outlook for future increases. The report explains the central bank’s confidence in hitting its inflation target while retaining a careful approach to future guidance. Future rate hikes are expected, although they may not occur before 2026.
The Bank of Japan conducted a 25bp hike and remained open to future increases. Governor Kazuo Ueda provided neutral comments regarding forward guidance. November’s Consumer Price Index met expectations, indicating ongoing inflation pressures, with another 25bp hike anticipated in the latter half of next year.
Sustainable Inflation Expectations
The meeting statement indicates confidence about sustainable inflation, mentioning expectations of consistent wage increases and low risks of disruption to firms’ wage-setting. Headline inflation is predicted to fall below 2% by early 2026 due to energy subsidies and declining rice prices. However, core inflation is expected to slow only slightly, staying above 2%.
USD/JPY is expected to decrease next year as foreign exchange hedging costs fall for Japanese holders of US debt securities. The three-month forward FX hedging costs have decreased to 3.22% per annum from a peak of 6.00% in late 2023.
The Bank of Japan has finally delivered its widely expected 25 basis point rate hike, confirming its growing confidence in sustainable inflation. However, Governor Ueda’s neutral forward guidance suggests that they are in no rush to move again. This signals a period of observation, which should dampen immediate volatility in the yen.
Future Inflation Projections
We do not expect another rate hike until the second half of next year, 2026. The latest November core CPI data, which excludes fresh food and energy, registered a 2.3% year-over-year increase, reinforcing the view that underlying price pressures are intact. The BoJ is likely to wait for more wage growth data in the spring before signaling its next move.
Headline inflation is projected to dip below 2% in the first few months of 2026, largely due to government subsidies and lower food prices. We saw a similar effect with energy subsidies back in 2024, which caused a temporary drop in the headline number without changing the central bank’s long-term policy direction. Therefore, traders should look past this anticipated short-term dip in the headline figure.
Over the coming year, we expect USD/JPY to trade lower. A significant factor is the sharp drop in the cost for Japanese institutions to hedge their US dollar assets. Looking back, these FX hedging costs peaked near 6.00% in late 2023 but have now fallen to just 3.22%, making it more attractive for Japanese funds to hold US debt and support the yen.
For derivative traders, this outlook suggests positioning for a stronger yen over the medium term rather than the immediate weeks. Selling near-term USD/JPY call options could be a strategy to capitalize on the expected period of calm. Further out, buying JPY call options with mid-2026 expiries could align with the timing of the next potential rate hike.
