Bank of Japan set to hold interest rates unchanged in March

• The Bank of Japan is expected to hold interest rates at 0.50% on Wednesday.
• The focus will be on the BoJ's hints on the timing and scope of future rate hikes.
• The Japanese Yen is set to rock on BoJ policy announcements-induced volatility.

The Bank of Japan (BoJ) is on track to keep the short-term interest rate steady at 0.50% following its two-day March monetary policy review on Wednesday.

Any signals on the timing and the scope of future rate hikes by the BoJ will likely infuse intense volatility around the Japanese Yen (JPY).

What to expect from the BoJ interest rate decision?

The BoJ is widely expected to pause its rate-hiking cycle this month after raising its policy rate to 0.50%, the highest level in 17 years, from 0.25% in January on the view that Japan was progressing toward achieving its 2% inflation target.

Just before the BoJ's January policy meeting, US President Donald Trump returned to the White House and proceeded with the proposed tariffs on China, Canada and Mexico. Trump's protectionism has triggered a tariff war globally, throwing major central banks worldwide in a dilemma.

Though rising inflationary pressures globally due to Trump's tariff could be a boon for the BoJ hawks, policymakers remain wary of Japanese economic prospects after the final Gross Domestic Product (GDP) increased 0.6% on a quarterly basis in the fourth quarter of 2024, a slower pace than the 0.7% expansion initially reported.

Despite escalating trade war and economic slowdown fears, BoJ Governor Kazuo Ueda and his colleagues continued to hint at further rate hikes if inflation moves sustainably toward its 2% target.

"Long-term interest rates move on various factors. But the biggest determinant is the market's forecast on the outlook for our short-term policy rate," Ueda told parliament on March 12, emphasizing the Bank's resolve to keep raising short-term interest rates.

This narrative seems to be backed by Japan's inflation remaining at its highest level since January 2023. The annual National Consumer Price Index (CPI) jumped 4% in January from December's 3.6% print. The so-called "core-core" inflation rate, which strips out prices of fresh food and energy and is closely monitored by the BoJ, rose slightly to 2.5% in the same period from 2.4% in the month before.

Further, the country's 10-year government bond yields recently surged to their highest level since October 2008, anticipating higher inflationary pressures. At the same time, the Japanese Yen (JPY) reached five-month highs against the US Dollar (USD).

More so, Japan's average monthly household spending rose 0.8% year-on-year (YoY) in inflation-adjusted real terms in January, marking the second consecutive month of growth.

The elevated cost of living brings closer scrutiny to the initial result of the spring wage negotiations (Shunto) announced on Friday. Japan's largest trade union group Rengo's first-round data shows an average wage hike of 5.46% for fiscal 2025, compared to the demand of a 6.09% hike. The results, however, came in above the last year's 5.28% raise.

These factors continue to raise expectations of rate hikes by the Japanese central bank in the upcoming months. The latest Bloomberg survey of economists showed that "July remained the favorite choice for the next hike with 48% expecting a move then, dropping from 56% in the previous survey."

Analysts at BBH said: "The two-day Bank of Japan meeting ends Wednesday with a widely expected hold. The bank just hiked rates 25 bp at the last meeting in January."

"BoJ Governor Ueda has cautioned that the policy path will be guided by checking the impact of rate hikes already undertaken, which argues against back-to-back rate hikes. The swaps market is pricing in the next 25 bp rate increase for September," the analysts added.

How could the Bank of Japan's interest rate decision affect USD/JPY?

If the BoJ reiterates that it will remain data-dependent and decides on a meeting-by-meeting basis, the Japanese Yen will likely resume its recent bearish momentum against the US Dollar (USD), driving USD/JPY back toward the March high of 151.31.

On the contrary, USD/JPY could fall hard toward 146.50 on a fresh JPY rally if the BoJ debates the next rate hike as soon as May due to concerns about inflationary pressure from wage gains, stubborn rises in food costs, and the trade war's impact.

Citing a source familiar with the BoJ's thinking, Reuters reported last week, "Japan's economy and price developments appear on track, but overseas risks have risen." "The heightening global uncertainty is a concern and could affect the BoJ's rate-hike timing," the source said, a view echoed by two more sources.

However, any knee-jerk reaction to the BoJ policy announcements could be reversed once Governor Ueda addresses the post-policy meeting press conference at 6:30 GMT.

From a technical perspective, Dhwani Mehta, Asian Session Lead Analyst at FXStreet, notes: "USD/JPY appears at a critical juncture, exposed to two-way risks in the lead up to the BoJ's decision. The pair has recaptured the 21-day Simple Moving Average (SMA) at 149.14, but the 14-day Relative Strength Index (RSI) remains beneath 50 despite the recent upswing."

"A hawkish BoJ hold could revive the USD/JPY downtrend, targeting the March 13 low of 147.41. The next support is seen at the 147.00 threshold. A sustained break below that level would challenge the five-month low of 146.54. On the flip side, buyers need acceptance above the 150.00 psychological level to extend the uptrend toward the March high of 151.31. The 200-day SMA at 151.93 will act as a tough nut to crack thereafter," Dhwani adds.