The Bank of Japan (BOJ) has decided to keep its short-term interest rate steady at 0.5%. This decision was unanimously supported by all members. Along with this, the BOJ has updated its inflation forecasts, revealing that they expect inflation to be higher. The new forecast for the core Consumer Price Index (CPI) for fiscal 2025 is 2.7%, an increase from the previous 2.2%. For fiscal 2026, the forecast went up to 1.8% from 1.7%, and for fiscal 2027, it is now projected to be 2.0%, up from 1.9%. The core-core CPI also saw similar updates, with forecasts for fiscal 2025, 2026, and 2027 changing to 2.8%, 1.9%, and 2.0%, respectively.

BOJ Inflation and Economic Outlook

The BOJ suggests that underlying inflation might start slow, but it is expected to gradually rise, aiming for a 2% target from fiscal 2025 to 2027. While risks to inflation and the economy appear balanced, they lean slightly downwards. There is also uncertainty regarding trade policies and their effects on the global economy and prices. Japan’s economy is showing moderate recovery. Inflation expectations are rising, accompanied by a gradual increase in wages and prices. Trade policy progress, especially with the Japan-U.S. trade agreement, is evident, but uncertainties still linger over future economic and trade conditions. The Bank of Japan has kept rates at 0.5% as anticipated. The key point is the significantly higher inflation forecast, with core inflation now estimated at 2.7% for this fiscal year. This suggests the bank may become more serious about future rate increases. This decision seems justified, especially since Tokyo’s core CPI for June 2025 unexpectedly reached 2.9%. Additionally, this year’s spring wage negotiations have resulted in an average increase of 4.5%, the highest in over 30 years. These figures indicate that the wage-price cycle the BOJ aims for is starting to take shape.

Strategies for Traders

For those trading derivatives, it’s important to consider interest rate swaps and futures. The market will likely begin pricing in a higher chance of a rate hike before the end of 2025 rather than waiting until 2026. We might want to adjust our positions for a steeper yield curve, anticipating that short-term policy rates will increase faster than expected. We should also brace for more volatility in Japanese government bonds (JGBs). We remember how small policy signals led to significant market fluctuations when the BOJ first began to change its yield curve control in 2023 and 2024. Buying options like straddles on JGB futures might be a smart strategy to profit from the anticipated market swings in the coming weeks. The yen’s situation is a bit more complex for option traders. Despite the BOJ’s shift towards a stricter approach, the yen has remained weak against the dollar, with USD/JPY recently trading above 165. This indicates that the popular carry trade, where traders borrowed yen at low rates, is slowly unwinding. Given this uncertainty, buying yen call options could be a good idea, acting as puts on the USD/JPY pair. A longer-term option, perhaps for late 2025, could allow us to profit from a sudden strengthening of the yen if the BOJ takes bolder actions than expected. However, there is a risk that these options could expire worthless if the bank continues to delay. Create your live VT Markets account and start trading now.

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