Japan may declare victory over deflation this week. What changes?

What happened

The Bank of Japan meets on 29–30 October. Every economist in a Bloomberg survey expects it to keep its policy rate at 1.25%, after raising it in September, its second rise in three months. The real news is expected in its quarterly outlook: Kyodo and other outlets report that the bank is likely to judge that underlying inflation has reached its 2% target. Governor Kazuo Ueda has described it as "very close" in recent weeks.

Why "underlying" inflation is the key word

Japan's headline inflation has been above 2% for about four years, but much of that came from imported energy and a weak yen. Price rises driven by import costs can fade. The BoJ wanted proof that prices and wages were now rising together, at home, year after year: that is what "underlying" inflation tries to capture. Core inflation was 2.1% in September, and wage rises have been the strongest in decades.

Saying the target is met is the end of a campaign that began in 2013, when the BoJ started buying bonds on a massive scale to escape deflation. It ended negative interest rates only in March 2024.

Why it matters: the neutral rate

Once inflation is at target, a central bank no longer needs to stimulate the economy. It wants its rate near "neutral", the level that neither speeds up nor slows the economy. The BoJ puts that somewhere between about 1% and 2.5%. With inflation at 2%, a 1.25% rate still leaves the real rate, after inflation, below zero: still stimulating. That is why the milestone is seen as the case for further rises. Over 80% of economists in the Bloomberg survey expect one in December.

It also matters for the yen. Higher Japanese rates narrow the gap with US rates, which has kept the yen weak; it traded around 158 per dollar after the Fed's decision.

Where it sits in the chain

This is Link 3, expected interest rates, seen from Japan. Each step towards a "normal" rate changes the yen, Japanese bond yields and the cost of Japan's large government debt.

What to watch

• The wording of the outlook report and the board's vote on Friday 30 October.
• Ueda's press conference: any hint about December.
• The yen and Japan's 10-year yield in the hours after the decision.