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Markets have priced in a 90% chance of a rate hike by the Bank of Japan this month, shifting attention to how the central bank signals its longer-term policy path.

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MUFG is among top Japanese players in the foreign exchange market and the largest owner of Japanese government bonds among major banks.

“If the BOJ fails to anchor expectations for further rate hikes beyond the next and the government boosts spending to appease voters frustrated with inflation, the yen could weaken further,” Hiroyuki Seki, the head of MUFG’s Global Markets Business Group, told Reuters in an interview.

“That could re-accelerate import costs, creating a negative spiral of inflation and currency depreciation,” he said.

Despite narrowing interest rate differentials with the United States, the yen has remained weak around 155 per dollar, partly reflecting market expectations that Prime Minister Sanae Takaichi’s reflationary stance could limit further BOJ tightening.

Seki stressed that eliminating Japan’s extremely low real interest rates was essential.

“The BOJ needs to move early and steadily toward monetary normalization to preempt a vicious cycle where insufficient tightening allows yen depreciation to push inflation even higher,” he said.

Beyond the potential December hike, Seki expects the BOJ to follow a gradual normalization path, raising rates by 25 basis points roughly every six months, provided economic and price trends evolve in line with the central bank’s projections.

The so-called terminal rate – the level at which the tightening cycle is expected to end – is projected at 1.25%-1.5% by mid-2027, though risks are skewed higher if inflation proves sticky, he said.

The BOJ has released estimates suggesting Japan’s nominal neutral interest rate – one that neither cools nor overheats the economy – lies somewhere between 1% and 2.5%.

On MUFG’s Japanese government bond strategy, Seki said the bank has been cautiously rebuilding positions since the benchmark 10-year yield rose above 1.65%.

“If the yield exceeds 2%, we plan to accelerate the pace of rebuilding, mainly on 10-year bonds, in line with higher interest rates,” he said. MUFG has substantial capacity for purchases given its currently restrained risk exposure, he added.

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