Bank of Japan expected to stand pat on interest rates, awaiting PM Takaichi's moves

• The Bank of Japan is widely expected to keep interest rates unchanged at 0.5% for the sixth consecutive time on Thursday. 
• The central bank is likely to wait for the Takaichi cabinet's first moves to resume its monetary tightening cycle.
• A dovish hold on Thursday, with no signs of an upcoming rate hike, might send the Yen tumbling.

The Bank of Japan (BoJ) meets on Thursday and is expected to keep its benchmark interest rate unchanged at 0.5%, awaiting the first moves of Prime Minister Sanae Takaichi's new cabinet.

Market hopes that the BoJ will continue normalising its monetary policy remain intact, and some central bank policymakers have confirmed that theory. Expectations of an interest rate hike in October, nevertheless, have receded, following the election of the fiscal dove Takaichi as Japan's Prime Minister in mid-October.

In this context, investors will keep their focus on the vote split, expecting to see some dissenting voices, and on the tone of BoJ Governor Kazuo Ueda's press conference, seeking validation of a rate hike in December or, at the latest, in January. 

What to expect from the BoJ interest rate decision?

As it stands, the BoJ is expected to maintain its monetary policy unchanged for the sixth consecutive meeting in October and reiterate its commitment to gradual monetary tightening.

A recent Reuters poll showed that 60% of analysts expect the Bank of Japan to raise its benchmark interest rate to 0.75% from the current 0.5% before the year-end. Data from the overnight swaps market, however, revealed that the chances of an October hike have dropped to about 24%, from 68% last month.

The new Prime Minister Takaichi, an assistant of former Prime Minister Shinzo Abe, has defended a looser fiscal policy and pledged to reassert the government's authority over the Bank of Japan and its monetary policy. This has raised concerns about the central bank's independence, dampening market expectations of immediate rate hikes.

With this in mind, the stubbornly strong inflation is likely to pose a serious challenge to Takaichi's aim of an expansive monetary policy. Data released last week revealed that the National Consumer Price Index (CPI) accelerated to 2.9% in September, from the previous 2.7%, remaining above the central bank's target for price stability.

Beyond that, service-sector inflation has picked up for the second consecutive time in September, endorsing the BoJ's view that rising labour costs will keep price pressures sustainably above the central bank's 2.0% target in the coming months.

Against this background, some BoJ policymakers have called for immediate rate hikes. Board Member Hajime Takata said last week that now is the appropriate time to raise interest rates, noting that inflation has remained above the bank's target for three and a half years already, and the economic risks stemming from US tariffs have eased. BoJ Governor Ueda, however, has been showing a more cautious view.

How could the Bank of Japan's monetary policy decision affect USD/JPY?

In this context, investors have already assumed a delay of the next rate hike, but they are likely to look for confirmation that the plan to keep normalising the monetary policy remains in play. A dovish hold, with no mention of upcoming rate hikes, might disappoint markets and send the Japanese Yen (JPY) on a tailspin.

The Yen lost more than 2% against the US Dollar (USD) in the week after Takaichi secured support to form a cabinet in mid-October. This week, USD/JPY has whipsawed, pulling back following the agreement between the US and Japan, and higher hopes of a China-US trade deal, to bounce up again following Chairman Jerome Powell's hawkish comments after the Fed's monetary policy decision on Wednesday.

USD/JPY 4-Hour Chart

From a technical perspective, Guillermo Alcalá, FX analyst at FXStreet sees the USD/JPY pair looking for direction with key resistance below the 153.20 area: "The risk is on a too dovish BoJ statement, which might disappoint investors and send the pair back beyond the eight-month highs, at the 153.25 area, aiming for mid-February highs, at 154.80."
"On the other hand, clear signals hinting at a rate cut in December or a high number of dissenters would give fresh hopes for Yen bulls to retest the October 21 and 22 lows, at the 151.50 area," says Alcala.