By Leika Kihara
TOKYO, Oct 26 (Reuters) - The Bank of Japan will likely declare victory in a nearly 14-year battle to hit its 2% inflation target at its policy meeting on Friday and emphasise the risks prices could overshoot, signaling the chance of a rate hike as soon as December.
Such hawkish language may reinforce expectations the BOJ, US Federal Reserve and European Central Bank will all raise rates by year-end, as brisk AI demand and the Iran war-induced energy shock worsen global inflationary
pressures.
Still, the BOJ is likely to avoid dropping explicit hints on the timing and pace of future rate rises as it balances the need to forestall risks of an inflation overshoot without disrupting jittery markets with a premature hike, analysts say.
"With rises in prices and wages moderate, the BOJ will keep raising rates gradually without rushing," said a person familiar with its thinking, a view echoed by two more people.
At the two-day policy meeting ending on Friday, the BOJ is set to maintain its policy rate at 1.25% by a majority vote, forgoing a back-to-back hike to spend more time scrutinising the effect of past rate hikes on lending conditions.
In a quarterly report due after the meeting, the BOJ is likely to slightly revise up next fiscal year's price forecast and signal that underlying inflation has roughly achieved its 2% target, people familiar with the matter have told Reuters.
With wage gains becoming embedded and inflation expectations hovering around 2%, the central bank will likely stress that it will now focus on anchoring inflation around its target by raising rates toward levels deemed neutral to the economy.
While Governor Kazuo Ueda has already signaled such a shift in policy focus upon raising rates in September, the pivot would mark another symbolic departure from the BOJ's prolonged efforts to fire up inflation through ultra-loose monetary policy.
"It's a historical moment for the BOJ, though it faces a more challenging task now that it needs to step not just on the accelerator but the brakes," said Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities.
"The BOJ will probably scrutinise upcoming data and market moves in deciding whether to raise rates in December, or hold until January," she said.
Analysts polled by Reuters expect the BOJ to raise rates to 1.5% in December and stick to a quarterly pace of rate hikes.
FUNDING STILL LOOSE
Under former governor Haruhiko Kuroda, the BOJ deployed a massive stimulus in 2013 to pull Japan out of deflation and fire up inflation to its 2% inflation target.
Even after ending its mix of unorthodox easing steps in 2024, the central bank has trodden cautiously in raising rates on the view underlying inflation - or price moves excluding one-off factors and driven by domestic demand - remained below target.
With stubbornly high energy costs and rising import prices from a weak yen adding to inflationary pressures, the BOJ raised rates in September after delivering a hike in June - a shorter interval than the roughly twice-a-year hikes in 2024 and 2025.
The BOJ's policy rate, at 1.25%, is now within the range of 1.1% to 2.5% its staff estimated as Japan's neutral rate, or the level that neither cools nor overheats the economy - drawing market attention to how far it could eventually hike rates.
With growth in bank lending still strong, the central bank is likely to stress on Friday that financial conditions remain loose - signalling scope for further rate hikes before its policy rate reaches levels close to neutral, the people said.
The BOJ's meeting follows that of the Fed, which is seen skipping a hike at its two-day meeting concluding on Wednesday. The ECB is also set to keep rates unchanged at 2.5% on Thursday.
(Reporting by Leika Kihara; editing by Sam Holmes)
