ING forecasts the Bank of Japan will raise rates by 25bp at its June meeting, citing resilient growth, negative real interest rates and ongoing upside risks to inflation. May inflation came in at 1.4% year on year, but this was linked to government interventions and last year’s high food-price base, while pipeline prices have risen since March and a weak yen is expected to add to price pressures. The April meeting saw three dissenting votes in favour of a hike, and two other policymakers have since indicated support for further normalisation.
The bank expects conditions to allow continued tightening, with growth near potential and inflation projected to stay around 2% through 2027, taking the policy rate to 1.50% by mid-2027. The BoJ will also set out its latest Japanese Government Bond purchase plan in June; it is currently cutting purchases by 200 billion JPY per quarter through next March, though a pause is possible if market functioning is deemed improved. Even with a pause from next April, holdings should keep shrinking as redemptions remain large, and ING sees the 10-year JGB yield rising to 3.0% by 2027.
Positioning for Higher Rates and Stronger Yen
Given the high probability of a 25-basis-point rate hike at the Bank of Japan’s meeting later this month, we believe traders should position for higher short-term rates. The latest Tokyo Core CPI for early June rebounded to 2.1%, confirming that underlying price pressures are building as government subsidies fade. One way to prepare is by entering interest rate swaps to receive a floating rate, which will benefit as the policy rate rises.
The case for a hike is also supported by strong domestic fundamentals, with the recent Shunto spring wage negotiations finalizing at a 4.5% average increase, the highest in over 30 years. This wage growth, combined with a persistently weak yen holding above the 165 level against the dollar, creates undeniable inflationary pressure. We see this as a clear signal to build positions that benefit from a stronger yen, such as buying JPY call options.
Bond Market Outlook and Yield Curve Strategies
For the bond market, we anticipate a gradual rise in 10-year JGB yields rather than a sharp sell-off. The central bank is likely to be very cautious about tapering its bond purchases to maintain market stability, even as it hikes the policy rate. Traders could consider slowly building short positions in JGB futures, anticipating that yields will climb moderately over the coming months.
This policy mix, a firm rate hike combined with a gentle approach to bond tapering, suggests a yield curve steepening strategy. We think it is prudent to position for the spread between short-term and long-term government bond yields to widen. This can be achieved by using derivatives to bet on 2-year yields rising faster than 10-year yields.
