Logic suggested that the hawkish hints from Bank of Japan Governor Kazuo Ueda would send USD/JPY sharply lower. The pair did indeed plunge, but then recovered most of its losses, while the yen gave back nearly all its gains against the US dollar.

The Bank of Japan kept its overnight rate at 1.25%, as the market had expected, with the board voting 8-1 in favor of the decision. Asked about the pace of future rate hikes, Kazuo Ueda said that the regulator would assess the situation at every meeting, including the next one.

The Bank of Japan declared a major victory in its years-long fight against deflation, much like a captain spotting land after a long voyage through the fog. Core inflation reached approximately 2% for the first time since 2013, when the regulator signed an agreement with the government to overcome deflation. This strengthens confidence in further monetary policy tightening.

Inflation Dynamics in Tokyo

Consumer prices in Tokyo, excluding fresh food, rose by 2.6% year over year in October, compared with 2.7% in September, in line with economists' forecasts.

The market now assigns a 75% probability to an overnight rate hike on December 18. The Bank of Japan pledged to monitor the oil crisis triggered by the war in the Middle East, the inflationary impact of the weak yen, and demand driven by the artificial intelligence boom.

Projections for the Timing of Overnight Rate Hikes

The Bank of Japan's decision brought a difficult week for major central banks to a close. The Fed and the ECB also opted to pause despite persistent inflation, so the Japanese regulator simply had fewer reasons to rush.

The Bank of Japan raised its economic growth forecast for the current fiscal year to 0.7% from 0.6%, although the pace of growth remains modest. Nevertheless, the inflation argument appears convincing enough to justify an overnight rate hike at the next meeting.

Mizuho Securities expects the December move to be followed by further overnight rate hikes in March and June 2027, bringing the rate to its terminal level of 2%. Bloomberg Economics expects the monetary policy tightening cycle to end at the same level after three 25-basis-point rate hikes in December, March, and July.

Bloomberg Economics also notes that the reaffirmed inflation target supports the yen, but high oil prices cast a shadow over this outlook for USD/JPY. The risk of a renewed escalation in the conflict between the United States and Iran following the midterm elections has pushed oil prices higher and could prevent the pair from fully benefiting from US dollar weakness amid concerns surrounding artificial intelligence.

The Bank of Japan has achieved a significant milestone in its long-standing fight against deflation. However, the central bank appears to be marking this achievement with restraint rather than making a bold statement.

Technically, on the daily USD/JPY chart, the pair rebounded from its fair value at 158.15 while the Deception-Breakout pattern was unfolding. This indicates weakness among the bulls and supports a focus on short positions targeting 156.5 and 155.1.