2025 Analyst survey: Bigger in Japan

The BoJ presses on with rises in interest rates; the door is open for more.

Originally published on January 24, 2025, by Fidelity International
Written by Peiqian Liu, Asia Economist, and Patrick Graham, Senior Investment Writer.

The Bank of Japan’s (BoJ) third rise in interest rates was widely expected, but its upping of inflation projections, the relative calm with which markets have taken the start of the Trump administration and continuing rises in domestic wages lay the ground for more hikes.

What happened

At its January meeting, the BoJ voted 8-1 to raise benchmark rates by another 25 basis points, to 0.5%, and promised to move forward with further rises if inflation and growth evolve in line with its new quarterly outlook.

The outlook increased the BoJ’s forecast for core inflation to as high as 2.7% in the 2024 fiscal year, from 1.9% to 2.4% in 2025, and to 2.0% for 2026. The higher projections were attributed to the rise in rice prices and to the impact of the recent depreciation of the yen on import prices. The increase in the 2026 projection may be the most significant, as it suggests the BoJ believes inflation can be kept at or above its 2.0% target.

On growth, the bank kept its real GDP projections unchanged, but it also showed more confidence in companies’ wage and price-setting behaviour: it expected them to raise wages further in this year’s annual spring labour-management wage negotiations and, with the labour market tight, predicted changes in wage and price-setting behaviours would continue in line with moderately rising inflation expectations.

There was a new nod to the risks from policy uncertainties and the impact of higher interest rates in both the U.S. and Europe since the pandemic, but the bank also noted that the U.S. economy has remained solid and global financial and capital markets are stable.

The BoJ expects real interest rates to remain significantly negative, providing accommodative financial conditions that can to firmly support economic activity. The bank also said that it needed time to consider its ETF holdings before making further changes to the current quantitative tightening policy.

In the press conference, BoJ Governor Kazuo Ueda reiterated that whilst there has been no market shock since President Trump’s inauguration, uncertainties remain about the new administration’s approach to tariffs and the potential for economic disruption.

Our interpretation

The rate hike and the revisions on inflation signal the bank’s confidence about wage and inflation growth dynamics. The ongoing positive momentum of wage negotiations and somewhat calm financial market reaction to President Trump’s early days in office also presents an appropriate opportunity to move a step further towards normalization.

The BoJ seems to be comfortable to pause and assess the impact of its tightening so far but while it will be data and events-dependent, the bank will continue with rate hikes if growth and inflation evolve in line with its projections. External uncertainties and the level of the yen will also be important factors affecting the pace and scale of any further hikes.

Governor Ueda gave little forward guidance on that pace, and the messaging sent to markets was neutral; still, he acknowledged that the current policy rate is far from neutral and that there will be more policy tightening in the pipeline. The risk to that is the global economic outlook, with the geopolitical situation still high on the agenda.

Outlook

Any future tightening may depend on the rate of imported inflation subsiding as the yen strengthens and the future course of overseas economies, especially in the U.S. and China.

The external environment remains calm so far, but we are on a close watch for any new developments that could impact Japan’s growth outlook or currency stability. Domestic-driven inflation will hinge on ongoing wage negotiations and their effect on inflation.

We believe that the virtuous cycle of wage and price rises is likely to be sustainable, resulting in a higher neutral rate for Japan. Accordingly, the BoJ may need to hike its policy rate further to adhere to its 2% inflation target if the wage price cycle gains momentum.

We maintain the medium-term view that the BoJ will continue with policy normalization to bring the nominal policy rate to 1% by the end of this year, although the bank will have to maintain a delicate balance between reflation efforts, external uncertainties and their impact on the yen and domestic growth momentum.

 

Allocation views: George Efstathopoulos, Portfolio Manager

I am constructive on Japanese equities. The domestic backdrop is on an improving trajectory, supported by strong wage growth and broadening demand-led inflation, which is leading to a multi-decade shift in consumption behaviour. Moreover, the recent developments on the political spectrum have led to additional fiscal stimulus which is supportive for domestic demand; all of which should drive earnings higher for the domestically sensitive mid caps.

More recently, I’ve also turned more positive on Japan large caps. Corporate reforms, through rising dividend payouts and buybacks, remain a structural tailwind. This is not “new” news, but the earnings resilience we are observing is. Japan currently enjoys the highest earning revisions compared to most of its developed market peers. The lack of significant reaction to today’s BoJ decision from the equity market is also an important risk-clearing event; investors who were scared by the carry-unwinding episode last August can now firmly put that behind them and instead focus on the improving fundamentals.

I increased my exposure to the yen in the run-up to the meeting, expecting a stronger currency, and the hawkish BoJ has delivered.
Tariff escalation is a concern given Japan’s large current account surplus with the U.S., but Japan is of strategic importance, and as such, a deal with the new administration should be swift in the making. Moreover, President Trump has been very vocal about exporters shifting production into the U.S. to avoid tariffs, an area where Japan already scores very favourably compared to the United States’ other key trading partners.

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