High uncertainty means a cautious the Bank of Japan

The Bank of Japan kept its policy rate at 0.5% at its September meeting by a 7-2 majority vote. Contrary to rising bets on a rate hike this year, we think high economic uncertainty will persuade the central bank to stay cautious, taking a pause before hiking again in the middle of 2026.

Although growth in Q2 GDP was healthy, the full impact of high US tariffs on the economy has yet to feed through. Indeed, the BoJ has stressed the high uncertainty regarding the impact of US tariffs in its recent communications, while maintaining its commitment to continue rate normalisation if the economy performs as it expects.

We believe the risk of falling behind the curve is limited despite still high inflation, which is largely supply-driven and should ease, as suggested by subdued import costs. That said, inflation developments are likely to underpin the gradual rate hike cycle – some sectors are showing tentative signs of wage-driven inflation, while consumer inflation expectations remain elevated.

The BoJ will also likely want to gauge the debate at the upcoming Liberal Democratic party (LDP) leadership contest in early October and the stance of the new administration. So far, most candidates have not officially opposed monetary policy normalization.