Bank of Japan likely to stay course with a rate hike in December or January, analysts say

After a messy election, the Bank of Japan decided to hold its benchmark policy rate at 0.25%, as expected. But analysts say that the central bank's focus on normalizing monetary policy — raising rates — remains unchanged.

The BOJ board maintained its three-year inflation projections with minor adjustments, signaling that the economy is progressing in line with its expectations. 

At a press conference following Thursday's decision, Kazuo Ueda, the central bank's governor noted that risks surrounding the U.S. economy are easing, an indication that conditions may soon be favorable for another interest rate hike. The yen rose to 151.9 against the dollar after Ueda's comments.

Stefan Angrick, associate director and senior economist at Moody's Analytics, described the tone of the BOJ's Outlook Report as being "moderately" hawkish. "If you look at the central bank's projections for growth and inflation, those still suggest that rate hikes are on the horizon," he said.

"The only question really is timing, and with the yen weakening still, my money will be on a rate hike before the end of the year, and what happens next year will depend on the Shunto or spring wage negotiations," Angrick added, in reference to annual wage negotiations between labor unions and employees in Japan.

The outlook report did cite risks to prices being skewed "to the upside for fiscal 2025," which economists say is likely a reference to concerns around a weakening yen. 

The yen dropped by about 1% to a three-month low on Monday following the worst election loss for the ruling Liberal Democratic Party in 15 years. On Friday morning, the yen was trading at 152.27 against the dollar.

A weaker yen generally benefits large Japanese firms with international operations by boosting the value of profits brought back from overseas. However, the downside is that a softer yen raises the cost of imported energy and food, putting pressure on households.

The BOJ's outlook report also noted the need to closely monitor global economic and market trends, underscoring its attention to risks that could impact a delicate domestic recovery when considering the timing of policy tightening.

Akira Otani, senior Japan economic adviser at Goldman Sachs, predicted that the BOJ would move to hike rates in January. These outlook risks highlight that the timing of the next BOJ rate hike could depend heavily on developments overseas, as well as the exchange rate and its impact on the Japanese economy, Otani added.

On domestic politics, Marcel Thieliant, head of Asia Pacific at Capital Economics, told CNBC that the next key point to watch is the potential passage of the supplementary budget.

During the election campaign, Prime Minister Shigeru Ishiba had stated that his government intends to put together a supplementary budget for the 2024 fiscal year to fund an economic aid package. He added that it would surpass the 13 trillion yen ($84.6 billion) allocated in last year's supplementary budget.

However, the budget size may increase further if the administration decides to incorporate the Democratic Party of the People's suggestions to ease the rising burden of energy cost.

Elections to determine a prime minister is set to take place on November 11. If he holds on to power, Ishibia would then form his second Cabinet, before flying to Brazil to attend meeting of the Group of 20.

When Ishiba returns, he is expected to hold an extraordinary Diet session, during which he hopes to pass the supplementary budget plan, according to local news.

"The Diet should be convening on 11th November, and typically the session runs until mid-December, so that should give them enough time to pass the supplementary budget," Thieliant said. Then the BOJ could hike rates that same month.

"If they don't. If, for some reason, that's delayed because of political problems. Then I would probably rule out a rate hike in December, because that would create a lot of uncertainty about the fiscal situation."