Bank of Japan expected to stand pat in July, focus shifts to rate hike clues at the press conference

The Bank of Japan is expected to keep its policy rate unchanged at 1.0% during its July monetary policy meeting, with market attention now fully focused on Governor Kazuo Ueda's press conference and the quarterly "Outlook Report," in search of key signals regarding the timing of the next rate hike.

As Kazuo Ueda was absent from the last meeting due to illness, this press conference will be the first direct opportunity for the public to assess his policy stance.

According to Quanfeng Trading Desk, Morgan Stanley noted in its July 21 research report that Ueda's statements—especially any differences between his personal view and the stance of the Bank’s Monetary Affairs Department—will dominate market pricing for the hike path in the near term. Currently, the market prices in the probability of a rate hike in September and October at approximately 24% and 68%, respectively.

Morgan Stanley's baseline scenario remains a rate hike in December, maintaining a pace of a hike roughly every six months, but considers an October hike as a risk scenario. In addition, if the meeting is interpreted as dovish, the yen could face a new round of broad depreciation pressure, with increased risk of foreign exchange intervention from the authorities.

On Tuesday, the USD/JPY broke above the 163 level, touching this level for the first time since 1986.

On Hold in July, Focus Shifts to Next Step

Morgan Stanley expects the Bank of Japan to keep its policy rate unchanged at 1.0% during the July 30–31 monetary policy meeting. Having just raised rates in June, the July pause has already been widely priced in by the market. The key issue now is signals regarding the timing of the next hike.

The Bank of Japan’s confidence in the resilience of both domestic and external demand is growing, while it remains alert to the risk of higher inflation.

On external demand, global AI and semiconductor demand remains strong, not only boosting actual exports of related goods but also supporting export prices, which to some extent offsets the deterioration in trade terms caused by rising oil prices. On internal demand, the Bank’s consumption activity index remains robust, and private consumption is expected to be assessed as resilient, especially service consumption as the main support.

On inflation assessment, the central bank is expected to maintain the language added in the June meeting—that the transmission of rising corporate goods prices to consumer prices may proceed at a relatively fast pace, with risks of broad-based transmission to the consumption sector, and that "core CPI inflation faces risks of deviating above the 2% price stability target."

Three Main Factors Supporting December Hike as Baseline

Despite a clear hawkish stance, Morgan Stanley remains cautious regarding the possibility of an early rate hike within the year and has listed three main reasons.

First, doubts remain over the strength of underlying inflation. Monthly CPI data shows private service inflation remains relatively stable, and as of May, stage-of-demand producer price indices and recent high-frequency price indicators both suggest that the pass-through from corporate goods prices to consumer prices is still gradual.

Second, uncertainties in the Middle East have flared up again. If the pass-through to retail prices continues to be slow while crude oil and naphtha-related product prices rise further, worsening trade conditions could weigh on nominal GDP and corporate profit growth, posing a downside risk to future wage growth. Ueda’s previous statements at press conferences indicate a cautious assessment stance towards Middle East risks.

Third, political considerations. According to a Reuters corporate survey in July, 49% of the companies surveyed believe that a hike to 1% by the Bank of Japan has had a "significantly negative" or "somewhat negative" impact, while 28% say the current interest rate level has had a negative impact on capital expenditure. Since the survey sample covers large enterprises with capital of no less than 1 billion yen, the actual impact on small and medium-sized enterprises could be greater. The Prime Minister's Office's emphasis on building a "strong economy" also means the central bank needs to more cautiously assess the consequences of further rate hikes.

Three Core Focus Areas of the Outlook Report

This Outlook Report has three core topics to watch particularly closely.

First, how the Bank presents the progress of the logic behind the June hike, namely the potential upside inflation risk stemming from the transmission of corporate goods prices to consumer prices. Data shows that the year-on-year increase in the corporate goods price index has continued to widen, reaching 5.4% in April, 6.6% in May, and 7.1% in June. Historically, the peak effect of the transmission from corporate goods to consumer prices usually manifests about six months later.

Second, whether risk-balance assessments among policy board members have shifted. If inflation forecasts are revised lower and economic growth forecasts are raised, the market will closely watch whether the risk assessment remains tilted towards potential inflation. This meeting will also be the first Outlook Report session for new members Sato and Asada; Asada has already expressed a cautious stance at the June meeting, while Sato’s policy bias will be tested by the market for the first time.

Third, whether the Bank provides an analytical framework for rate hikes above 1%. Internal recognition of the neutral interest rate band within the Bank has moved up to about 1.5–2.0%, and the 1.1% lower bound is no longer a valid reference in policy discussions. In this context, whether the Bank can provide a more concrete standard for measuring the degree of monetary easing will be an important basis for judging the path of subsequent hikes.

Ueda’s Press Conference Remarks Could Become Key for Market Pricing

Details in Kazuo Ueda’s press conference remarks will be a key variable for short-term market pricing. The opening statement and the first half of the Q&A may mainly reflect the Monetary Affairs Department’s stance, while the latter half of the Q&A will better embody the governor's personal judgment—nuanced differences between the two deserve special attention.

On the matter of weighting inflation data, the market will watch whether the Bank prefers to rely on actual inflation data, such as the corporate goods price index and CPI, or gives greater emphasis to inflation expectations in determining the timing of future hikes.

Furthermore, if Kazuo Ueda makes a clearer statement about the risk that "delayed rate hikes might push up the inflation risk premium and drive up long-term interest rates," this will also provide important clues for future policy trade-offs.