BoJ preview: Stubbornly weak Yen enabling BoJ and government to agree on 25-bps hike in December

The Japanese economy has been much more resilient than expected to the Trump tariffs and geopolitical risks but with the very weak Yen as the main problem.While the Bank of Japan (BoJ) has been vigilant against the negative impact of US tariffs, the Tankan survey revealed that the Japanese economy has held up well. The headline manufacturing sentiment for large companies slightly improved to +15 in December from +14 in September (Chart 1). The non-manufacturing was also stable at +34, as the negative impact on tourism from the China-Japan political tension has been limited so far. In fact, accommodation and eating services only fell to +25 from +26. While companies have been relatively confident with the current business condition, they are less certain about the outlook in March-2026.Furthermore, the virtuous circle between nominal wages and inflation continued to strengthen. Nominal regular wages picked up to +2.6% YoY in October from +2.0% YoY in September, while services inflation on consumer prices rose to +1.6% YoY from +1.4% YoY during the same period. On top of this, inflation expectations for the next one, three and five years were stable at +2.4%, above the BoJ’s 2% target.However, real wages have continued to decline, containing private consumption. Food prices which surged by +7.2% YoY in October lifted the core* CPI inflation to +3.0% YoY, eroding households’ purchasing power. This negative development could be reinforced by the weak Yen through higher import inflation. In fact, the Yen has been persistently weak at around USDJPY =155 despite of the 25-bps rate cut by the Fed in December (Chart 2).Given the increasing evidence that the weak Yen is a problem, with the pass-through to consumer prices biting on real disposable income, the Takaichi government seems to have become more open to a hike from the BoJ. On that basis, the BoJ is anticipated to hike by 25 bps to 0.75% on December 19th as inflation expectations remain above the BoJ’s 2% target. If further Yen depreciation were to occur after this hike, further feeding inflation and reducing Japanese households’ purchasing power, the Takaichi government might tolerate more action from the BoJ, in particular a further 25-bps hike early next year.