Japanese economy

31 July 2026, 11:44 UTC Chief Investment Office GWM Investment Research

BoJ: Perception of being behind the curve persists Japanese economy Authors: Kazumasa Ishii, Strategist, UBS SuMi TRUST Wealth Management Co., Ltd.; Chisa Kobayashi, Head CIO Japan Equity Strategy, UBS SuMi TRUST Wealth Management Co., Ltd.; Teck Leng Tan, CFA, Strategist, UBS AG Singapore Branch; Daiju Aoki, Chief Investment Officer Japan and Head Macroeconomics Japan, UBS SuMi TRUST Wealth Management Co., Ltd.; Jun Takahashi, Strategist, UBS SuMi TRUST Wealth Management Co., Ltd.

• The BoJ kept its policy rate unchanged at 1.0% at the July meeting as expected, and we maintain our forecast for rate hikes in December 2026 and June 2027.

• Although we believe the concerns that the BoJ is behind the curve are unfounded, they are likely to persist in the market as the headline inflation remains above 2% throughout 2027, warranting a risk premium in JPY and interest rates unless the communication by the government improves.

• Our end-2026 10-year JGB yield forecast remains unchanged at 2.7%, as we believe the current rate path has been priced in. We see further potential Source: iStock for gains in Japanese equities as market leadership broadens beyond AI, and a catch-up rally in cyclicals remains possible if energy supply normalizes.

Summary of the monetary policy meeting Chart 1 - The BoJ revised higher its FY26 growth As expected, the Bank of Japan (BoJ) kept its policy rate forecast unchanged at 1.0%. In its Outlook report, the BoJ also lowered its inflation forecasts and raised its GDP growth forecasts, reflecting policy measures and strong AI-related demand, as we expected.

At the press conference, Governor Ueda kept balanced tone, underscoring the upside risks to underlying inflation and intention to discuss further rate hikes from the next meeting while monitoring the data.

As a result, the 10-year Japanese government bond (JGB) yield edged up from 2.79% to 2.8%, while USDJPY ticked Source: Bank of Japan, UBS, as of July 2026 down from 160.8 to 160.5 as of the time of writing.

This report has been prepared by UBS SuMi TRUST Wealth Management Co., Ltd., UBS AG Singapore Branch. Please see important disclaimers and disclosures at the end of the document.

Tightening cycle to end after two hikes by mid-2027 Chart 2 - Underlying inflation remains below 2% We maintain our view that the BoJ will likely continue Consumer price index, %, y/y to raise interest rates gradually, while taking economic conditions into consideration. Specifically, we expect the policy rate to reach 1.5% following rate hikes in December 2026 and June 2027, marking the end of the current rate- hike cycle.

Meanwhile, headline inflation is likely to remain above 2% through 2027, excluding the impact of a consumption tax cut, as higher crude oil and naphtha prices are passed through to consumers. We expect inflation to rise to between 2.5% and 3.0%, depending on oil prices, around the turn of the year. In addition, exports remain strong, particularly due to AI-related demand, while consumption is also resilient. Given the favorable macroeconomic environment, we believe it is reasonable for the policy rate to be raised toward the neutral level, which we estimate at 1.5%. Source: Bank of Japan, UBS All items, less food (ex.alcohol), energy, and policy effect The risk scenario involves a higher terminal rate and earlier rate hikes. While a September rate hike seems too early A behind-the-curve situation generally occurs when wages to assess the impact of the previous rate hike, an October rise in response to goods inflation and those increases are rate hike could become possible if the yen weakens further, passed through to service prices, resulting in a wage-price despite rising long-term interest rates and foreign-exchange spiral. However, Japan’s wage growth is hovering round 3% intervention, amid concerns that the BoJ is behind the curve. y/y in 2026, below the 3.5% in the US and Europe and In addition, increased domestic investment related to AI nowhere near the increases of more than 5% y/y observed in demand and productivity gains could raise the neutral rate. the US and Europe in early…