BOJ's hawkish hold today: Why December could bring another rate hike

• BOJ's hawkish hold: Rates remained at 1.25%, but the BOJ now sees underlying inflation as broadly consistent with its 2% target, shifting its focus towards preventing a sustained overshoot.
  
  
• December hike increasingly likely: Higher FY2027 inflation forecasts, persistent wage and cost pressures, and accommodative financial conditions support our expectation of another 25bp hike in December.
  
  
• ETF disposal unlikely to disrupt markets: The BOJ accelerated annual ETF sales to approximately JPY2.46 trillion at market value, equivalent to just 0.1% of trading value, reinforcing monetary normalisation.
  
  
• Remain constructive on Japanese equities: We favour financials, semiconductor equipment and automation, while maintaining unhedged exposure to benefit from potential gradual yen appreciation.

After raising rates by 25 basis points to 1.25% in September, the BOJ opted to hold steady in October. However, beneath the unchanged headline rate, three important developments point towards further monetary tightening: a more hawkish assessment of inflation, upward revisions to next year's inflation forecasts, and growing confidence that Japan can sustain inflation around its 2% target.

The BOJ's inflation battle has entered a new phase

Perhaps the most significant development was not the interest-rate decision itself, but the BOJ's changing interpretation of inflation.

In its October Outlook Report, the BOJ assessed underlying inflation as generally consistent with its 2% target, compared with its earlier assessment that inflation was still approaching that level. The central bank's priority is therefore shifting from achieving 2% inflation towards ensuring that inflation remains sustainably anchored around the target, without persistently overshooting it.

The October vote also provided a hawkish signal. The decision to hold rates at 1.25% passed by an 8–1 majority, with board member Hajime Takata advocating an immediate increase to 1.50%. This contrasted with September's 7–2 decision to raise rates, when two board members opposed the hike and preferred to maintain the existing policy rate. Although the change in voting patterns does not necessarily indicate unanimous support for another hike soon, it suggests that the debate is increasingly centred on the appropriate pace of normalisation.

The most notable revision was the increase in projected FY2027 core inflation from 2.4% to 2.6%, primarily reflecting higher crude oil prices. Japan remains vulnerable to energy-price shocks because of its heavy reliance on imported energy. Although the BOJ assumes that global crude oil prices will gradually decline over its forecast horizon, this may not translate into an equivalent reduction in costs for Japanese businesses. Disruptions to Middle Eastern energy supplies have encouraged Japanese importers to diversify their sourcing. However, alternative procurement arrangements often involve additional transportation and logistical costs, meaning companies may continue facing elevated expenses even if crude prices retreat in FY2027.

More importantly, inflationary pressures appear to be spreading beyond energy. The BOJ raised its FY2027 core-core inflation forecast from 2.6% to 2.7%. While the revision was modest, it reinforces expectations that inflation will remain above 2% even after excluding the direct effects of food and energy.

First, higher energy costs are feeding into broader consumer prices. Rising fuel and transportation expenses increase manufacturing and distribution costs, encouraging companies to pass these increases on to customers.

Second, the global AI investment boom is creating additional input-cost pressures. Strong demand for advanced semiconductors and related components is pushing up prices for electronics manufacturers. Together with yen depreciation, this could contribute to higher prices for consumer durables.

Third, persistent labour shortages are reinforcing Japan's wage-price cycle. Companies are increasingly raising wages to attract and retain workers, supporting household purchasing power but also increasing operating costs. As businesses become more willing to pass higher labour expenses on to consumers, inflation could become more persistent.

Japan's sustained real wage growth over the first eight months of 2026 offers encouraging evidence that improving household purchasing power is supporting domestic demand, reinforcing the shift towards a more sustainable, domestically driven inflation cycle rather than one reliant primarily on imported cost pressures.

Table 1: The BOJ's updated economic projections reinforce its increasingly hawkish outlook

Dimension	September (17-18 Sep)	October (29-30 Oct)
Action	Hike 25bp to 1.25%	Hold at 1.25%
Vote	·       7-2 ·       Asada and Sato opposed the hike	·       8-1 ·       Takata wanted 1.50%
Rationale	Risk that inflation deviates above 2%	Underlying inflation "generally consistent" with 2%
Inflation verdict	Underlying inflation "approaching" 2%	Reached target, expected to stay
Ueda framing	Policy has entered a "new phase" (anchoring, not lifting, inflation)	Anchoring around 2% now the stated task
Board debate	Some members open to faster hikes; two preferred holding while CPI < 2%	No vote for a cut
Core CPI Projections vs July forecasts	·       FY2026: 2.5% ·       FY2027: 2.4%	·       FY2026: 2.5% ·       FY2027:2.6%
Core-core CPI Projections vs July forecasts	·       FY2026: 2.5% ·       FY2027:2.6%	·       FY2026: 2.4% ·       FY2027:2.7%
Real GDP	·       FY2026: 0.6% ·       FY2027:0.8%	·       FY2026: 0.7% ·       FY2027:0.7%
Source: BOJ meeting, Outlook for Economic Activity and Prices (October 2026), iFAST compilations. Data as of 30 October 2026.

The case for another 25-basis point rate hike in December strengthens

Against this backdrop, we believe the conditions are increasingly supportive of another 25-basis-point hike at the BOJ's December meeting.

First, core inflation is now broadly consistent with the BOJ's 2% target, reducing the justification for maintaining exceptionally accommodative monetary conditions. September's headline and core CPI inflation both stood at 2.1%, while the BOJ continues to project core inflation of 2.5% for FY2026. Although the latest monthly reading remains below this full-year forecast, the two measures are not directly comparable, as the BOJ anticipates further inflationary pressures over the fiscal year.

Second, financial conditions remain accommodative despite September's rate hike. With the nominal policy rate at 1.25% and September core inflation at 2.1%, a simple backward-looking calculation implies a real policy rate of approximately −0.85%. Although this is not a comprehensive measure of monetary restrictiveness, it illustrates that interest rates remain relatively low compared with prevailing inflation. The BOJ has similarly noted that real interest rates, particularly at shorter maturities, remain low, while financing conditions continue to support economic activity.

Some policymakers have discussed neutral interest rates around 2%. Using this figure as an illustrative reference would suggest room for another three 25-basis-point hikes from current levels.

Third, delaying normalisation for too long could increase the risk of more disruptive tightening later. With underlying inflation already around target, allowing price pressures to become increasingly entrenched could eventually require faster or larger rate hikes. By continuing to raise rates gradually, the BOJ may be able to contain inflation risks while giving households, businesses and financial markets sufficient time to adjust.

However, we do not expect the central bank to accelerate into an aggressive tightening cycle. Japan's growth outlook remains modest, with the BOJ projecting GDP growth of just 0.7% in FY2026 and FY2027. Elevated energy costs also threaten household purchasing power and corporate profitability.

Moreover, with Japanese 10 year and longer ends government bond yields already substantially higher than in previous years, an unnecessarily rapid tightening cycle could increase financing costs and create greater volatility in the bond market.

Our base case therefore remains another 25-basis-point hike in December, bringing the policy rate to 1.50%, followed by further gradual normalisation in 2027. Nevertheless, the timing remains dependent on incoming inflation, wage and consumption data, as well as developments in financial markets.

Market reaction: Why did equities fall, bond yields decline and the yen strengthen?

Despite the BOJ's increasingly hawkish stance, Japanese financial markets delivered a mixed response. On 30 October, the Nikkei 225 fell more than 2% during trading, Japan's 10-year government bond yield declined below 2.8%, while the yen strengthened modestly towards JPY157 per US dollar. These contrasting movements suggest that global risk sentiment and interest-rate differentials remain as important as domestic monetary policy in driving Japanese asset prices.

Japanese equities declined, but the sell-off was not solely BOJ-driven. Renewed concerns over the sustainability of global AI capital expenditure triggered weakness in technology stocks, particularly Japanese semiconductor-related companies. The BOJ's hawkish inflation assessment added pressure by raising expectations of further tightening, potentially increasing discount rates and weighing on valuations.

Japanese government bond yields fell despite expectations of further rate hikes. The 10-year JGB yield declined from around 3.1% in early October to below 2.8% on 30 October, reflecting stronger safe-haven demand amidst global equity volatility and declining US Treasury yields. With the October hold largely anticipated, investors appeared more focused on global growth risks and the BOJ's measured tightening approach. Nevertheless, further policy normalisation should support higher short-term yields over time, while longer-term yields remain sensitive to growth expectations, inflation and fiscal risks.

Meanwhile, the yen strengthened only modestly, highlighting the persistent influence of interest-rate differentials. USD/JPY briefly approached 157.1 following the meeting, supported by the BOJ's hawkish inflation outlook and lower US Treasury yields. However, Japan's policy rate remains well below US rates, preserving the attractiveness of yen-funded carry trades. This also explains why the yen weakened following September's widely anticipated hike. Looking ahead, we expect gradual yen appreciation as the BOJ continues normalising policy, although a sustained recovery will likely require a more meaningful narrowing of US–Japan interest-rate differentials.

BOJ accelerates ETF disposal: Another headwind for Japanese equities?

Beyond interest rates, the BOJ also announced an acceleration in the disposal of its substantial holdings of Japanese equity ETFs.

The central bank began purchasing ETFs in 2010 and sharply expanded the programme under former Governor Haruhiko Kuroda as part of Japan's unconventional monetary easing measures. The purchases were intended to support financial-market confidence and reduce risk premiums, but they also resulted in the BOJ accumulating an exceptionally large position in Japanese equities. After ending new ETF purchases in March 2024, the BOJ established a gradual disposal programme in September 2025.

At today’s policy meeting, BOJ announced that annual ETF sales would increase from approximately JPY330 billion to JPY860 billion at book value, effective January 2027. At current market valuations, the new annual disposal amount would be equivalent to approximately JPY2.46 trillion, reducing the estimated time required to unwind its holdings from 112 years to 43 years.

Figure 1: BOJ will accelerate ETF sales from January 2027

Source: Bank of Japan. Data as of 30 October 2026.

While the increase may appear substantial, we believe its direct impact on Japanese equities should remain manageable. The annual sales amount represents approximately 0.1% of market trading value, suggesting that the additional supply can be absorbed without necessarily causing significant market disruption.

Importantly, the BOJ has designed the programme to minimise market disruption, retaining the flexibility to adjust or temporarily suspend sales during periods of financial stress. This measured approach should help limit disorderly selling and reduce the risk of amplifying market volatility.

Beyond the immediate market impact, the accelerated disposal signals the BOJ's growing confidence that Japanese equities can function without extraordinary central-bank support. Over time, reducing the BOJ's ETF holdings could also facilitate a gradual shift towards greater private-sector ownership and market-driven price discovery. While the governance benefits are indirect, this transition would complement Japan's broader corporate reforms, including stronger shareholder engagement, increased share buybacks and the unwinding of cross-shareholdings.

Ultimately, we view the programme as a manageable adjustment rather than a fundamental threat to the Japanese equity market.

Investment implications: Higher rates create winners and losers

Despite the BOJ's hawkish stance, we remain constructive on the outlook for Japanese equities. The market's recent volatility illustrates that the transition towards higher interest rates will not necessarily be smooth. However, we believe monetary policy normalisation is likely to create a more differentiated investment environment rather than undermine the entire market.

Financials remain among our preferred beneficiaries

We maintain our positive view on Japan’s financial sector. Further monetary-policy normalisation should support banks’ net interest margins as lending rates adjust higher. Higher JGB yields can also improve investment income and spreads for insurers, although the benefits will depend on the pace and shape of the yield curve. The backdrop is further supported by structural improvements in Japanese corporate governance, capital efficiency and shareholder returns. Japanese financial institutions are therefore positioned to benefit from both higher rates and the broader shift towards more shareholder-friendly capital allocation.

For investors looking to capture this theme, we recommend the Amova Japan Dividend Equity SGD, which provides exposure to Japanese companies with an emphasis on dividend income. Despite its income focus, the fund has less than 5% exposure to real estate as of 30 September 2026, limiting its sensitivity to further rate hikes. Instead, the majority of its income is generated from the industrials and financials sectors.

Be more selective towards rate-sensitive sectors

Conversely, we remain cautious towards companies that are especially vulnerable to higher financing costs and rising discount rates.

J-REITs and real estate companies may face pressure as higher bond yields increase funding expenses and required property yields, potentially weighing on valuations. Highly leveraged businesses could also experience greater refinancing pressure, particularly where they lack sufficient pricing power to pass higher financing costs on to customers. Similarly, long-duration growth stocks may be more susceptible to valuation compression as discount rates rise.

We would also be selective towards exporters heavily dependent on yen depreciation to sustain earnings growth. While a stronger yen could reduce the translated value of overseas earnings, companies with genuine technological leadership and strong global demand should be better positioned to withstand currency volatility. This is particularly relevant for Japan's semiconductor equipment, factory automation and advanced manufacturing companies.

Although these sectors have experienced volatility amid concerns over AI capital expenditure, we believe their longer-term growth prospects remain supported by the increasing complexity of semiconductor manufacturing, rising demand for advanced testing equipment and continued industrial automation.

For investors seeking broad Japanese equity exposure, we continue to recommend the Xtrackers Nikkei 225 UCITS ETF 1D (LSE: XDJP), which offers a low annual expense ratio of 0.09%. Alternatively, Singapore investors seeking SGD-denominated trading, local market hours and a lower minimum investment outlay may consider the iFAST Xtrackers Nikkei 225 UCITS Index ETF (SGX: JPY). For investors preferring a more selective approach, we favour Amova Japan Equity SGD, which provides diversified exposure to Japanese companies across market capitalisations, focusing on opportunities in industrials, financials and consumer-related sectors.

Declaration:

This research report was prepared with the assistance of artificial intelligence (AI) tools. iFAST Financial Pte Ltd does not rely exclusively on AI for content generation; the content of this report – including all investment theses, ratings, price targets and conclusions – has been independently reviewed and verified by the research analyst(s) to ensure accuracy and professional integrity.

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.