BoJ hikes policy rate to highest level in the past 30 years and signals further tightening if conditions are right

Highlights: In its December meeting, the Bank of Japan (BoJ) lifted policy rate by 25bps, the first hike since January this year, to 0.75 per cent, the highest level in the past 30 years. The BoJ did not offer too much new hints as to when it might hike again. However, it did highlight that more increases are in the pipeline if economic and inflation conditions allow. We now expect another 25bp hike in Q3 next year. Meanwhile, we anticipate Japan’s economic outlook should remain resilient next year, supported by Prime Minister Takaichi’s JPY21.3 trillion economic stimulus package announced in November. Recent domestic trends in such as wage growth and business confidence have also been solid. We stay overweight on Japanese equities, neutral on JPY, and underweight on JGBs in our global asset allocation.

• One issue that has been of recent investor concern is uncertainties regarding Japan-China relations. However, our calculations indicate Chinese tourist spending accounts only for only 0.62 per cent of total consumption in Japan. As such, we believe that the current impasse in Japan-China relations should not have major implications to the Japanese economy. In fact, we note that other than some initial volatility, markets do not appear to be pricing-in a broad deterioration of the situation
• JPY (Neutral): We see USDJPY could possibly correct lower from recent levels in the coming months on narrower US-Japan rate differentials. Yet, market concerns about fiscal sustainability could stay elevated as Japan’s fiscal policy become substantially more expansionary, which would potentially keep the JPY muted
• JGBs (Underweight): We expect near-term volatility of JGBs, especially in longer end of the curve, as markets may be concerned about higher issuance of government debt and fiscal sustainability risks under Takaichi’s expansionary policy agenda. 10-year JGB yield rose above 2 per cent for the first time since 2006 after today’s BoJ hike
• Japanese equities (Overweight): We believe Japan can see a further domestically-driven rerating of its stock market. The earnings trend is supportive, with consensus projecting Japan stock market earnings to accelerate from 5 per cent in calendar year 2025 to 11 per cent in 2026. We also continue to see Japanese equities as an ideal diversifier within DM equities. We favour domestic reflation plays in Japanese technology, financials, and consumer stocks