The Bank of Japan is likely to keep its short-term policy rate at 0.5% in its upcoming meeting. A decision is expected between 0230–0330 GMT on July 31, 2025. There might be a shift towards a more positive outlook, possibly leading to rate hikes later this year. This change comes as trade tensions are easing due to Japan’s recent agreements with the U.S. and a broader deal with the EU, which could benefit Japan’s export economy.

Bank’s Cautious Approach

Despite these developments, the Bank remains cautious because of ongoing uncertainties, especially regarding the impact of U.S. tariffs. Deputy Governor Uchida noted that uncertainty has decreased with the U.S.–Japan deal, but worries about U.S. trade policy affecting the global economy remain. The upcoming quarterly outlook report is being closely watched. The Bank is likely to raise its inflation forecast for fiscal 2025, mainly due to rising food prices, like rice. It might also change its views on inflation risks, potentially dropping concerns over “downside risks” while still aiming for a 2% inflation target in the future. Current predictions include a core CPI of 2.2% for 2025, 1.7% for 2026, and 1.9% for 2027. More information may come out during Governor Ueda’s press conference at 0630 GMT.

Market Opportunities

Traders should focus not just on the rate decision, but on positioning for a more optimistic outlook. Since the Bank of Japan is expected to keep rates steady, traders can make money by anticipating how likely rate hikes are based on new information. This means looking at derivatives that respond to future expectations rather than just the current decision. The main impact will likely be felt in currency markets. A more confident central bank often leads to a stronger yen. We are considering buying JPY calls or using put options on the USD/JPY pair to prepare for a potential drop in USD/JPY, as the market may start expecting a higher chance of a rate hike by year-end. For perspective, after the Bank’s last major policy shift in March 2024, the yen rose nearly 4% against the dollar over the next few weeks. Anticipation of this announcement will likely cause increased currency volatility. We suggest strategies like long straddles on the USD/JPY, which can profit from significant price movements in either direction. Recently, one-month implied volatility on this currency pair spiked from 8% to over 11% in just one week due to hawkish comments, showing how sensitive this market is to future guidance. We expect forward interest rate markets to react before cash bond markets do. Traders should keep an eye on the 2-year and 5-year Japanese interest rate swaps, which will likely rise as they factor in future tightening. After the Bank’s last policy normalization, the 2-year swap rate increased by over 15 basis points, indicating that derivative markets often anticipate policy changes before they happen. A key detail to watch will be the wording in the quarterly outlook, particularly any upgrades to the inflation forecast. Japan’s “core-core” inflation, which excludes fresh food and energy, has now been above the 2% target for over 15 months, adding credibility to a more confident official stance. The removal of the term “downside risks” would give us the clearest signal to take on more hawkish positions. The deputy governor’s recent remarks about reduced uncertainty are likely intended as signals leading up to the meeting. However, the most significant market reactions will probably take place during the press conference following the decision. We will be listening for any clear indications from the governor about when the next hike might occur, as his remarks will be crucial for our short-term strategies. Create your live VT Markets account and start trading now.

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