Japan’s service-sector inflation remained close to 3% in October, according to data released on Tuesday. This suggests that the conditions for a potential interest rate hike by the Bank of Japan (BOJ) are aligning in the near term. While there is uncertainty surrounding U.S. President-elect Donald Trump’s policies, which could affect the global economic outlook, many analysts believe Japan’s economy will continue to recover moderately, helping to keep inflation near the BOJ’s 2% target. This includes developments in the services sector, where the services producer price index (SPPI), which tracks the prices companies charge each other for services, increased by 2.9% in October compared to the previous year, up from a 2.8% rise in September. This increase was driven by price hikes in services such as machinery repair, accommodation, and construction work, supporting the BOJ’s view that higher wages are encouraging more businesses to pass on increased labor costs through price increases.
As a result, the BOJ is likely to consider this data during its next policy meeting in December, where some analysts expect a rate hike from the current 0.25%. Former top BOJ economist Seisaku Kameda, now an executive economist at Sompo Institute Plus, commented that while service-sector inflation is broadening, the momentum may not be as strong as the BOJ suggests. However, he believes the central bank is likely satisfied with the ongoing rise in wages and service-sector inflation, and expects a rate hike in December. In a sign that sustained wage growth remains a top priority for the government, Prime Minister Shigeru Ishiba announced on Tuesday that he would ask companies to implement “significant” pay raises during next year’s labor negotiations with unions.
Despite these domestic signs of inflationary pressure, risks from global developments loom large. Service-sector inflation is under close scrutiny by the BOJ as an indicator of whether demand-driven price increases are widespread enough to warrant further interest rate hikes. October’s data is particularly significant, as many Japanese companies adjust service prices biannually in April (the start of the fiscal year) and October. The data also follows last week’s consumer inflation figures, which showed that the prices companies charged households for services rose by 1.5% in October year-on-year, up from a 1.3% increase in September. BOJ Governor Kazuo Ueda has stated that the economy is moving toward sustainable, wage-driven inflation, which could allow for additional rate hikes.
However, one of the biggest challenges for further BOJ rate hikes could be the impact of Trump’s policies, particularly his pledge to impose large tariffs on Canada, Mexico, and China, which could trigger a dollar rally and declines in Asian stock markets. The Japanese government has warned that Trump’s policies could affect Japan’s economy, including causing market fluctuations. Masakazu Tokura, chairman of the influential business lobby Keidanren, said Trump’s tariffs could inflict “severe” damage on Japanese companies. UBS has raised its forecast for the USD/JPY in a note Thursday, expecting significant fluctuations in the exchange rate over the coming year. The bank now projects the currency pair to reach 155 by December 2024, followed by 152 in March 2025, 150 in June, and 147 in September. By year-end 2025, UBS targets 145, a revision from its earlier predictions of 147, 143, 140, and 138, respectively. According to UBS, a near-term surge to 158-160 remains possible, especially if U.S. 10-year yields rise another 30-40 basis points, potentially hitting 4.8%. “Based on sensitivity analysis over the past three years, a 10bp widening of the US-Japan 10-year yield differential coincides with a one-yen rise in the USDJPY exchange rate,” UBS explained. If U.S. bond yields indeed spike to 4.8%, the bank says USD/JPY could temporarily reach 160, though they view this level as “unsustainable” and likely to invite Japanese intervention, as observed during similar peaks earlier in 2024.
