Markets are increasingly concerned about Japan’s potential “negative spiral” risk, a scenario in which monetary tightening lags inflation and a weak yen drives up prices. That is the central worry voiced by the markets chief at Mitsubishi UFJ Financial Group (MUFG).
Investors have priced in roughly a 90% probability of a Bank of Japan (BOJ) rate hike this month, shifting focus to how the central bank will outline its longer-term policy trajectory.
MUFG sits among Japan’s leading players in the foreign exchange space and is the largest holder of Japanese government bonds among major banks.
Hiroyuki Seki, who heads MUFG’s Global Markets Business Group, told Reuters that if the BOJ cannot anchor expectations for additional rate hikes beyond the upcoming move and if the government increases spending to placate voters frustrated by inflation, the yen could slide further. That scenario could lift import costs again, fueling a self-reinforcing cycle of higher inflation and weaker currency.
Even with narrowing rate differentials versus the United States, the yen has stayed weak around 155 per dollar. This weakness partly reflects market bets that Prime Minister Sanae Takaichi’s reflationary agenda could constrain further BOJ tightening.
Seki emphasized that eliminating Japan’s very low real interest rates is crucial.
"The BOJ must move promptly and gradually toward monetary normalization to head off a vicious cycle in which insufficient tightening lets yen depreciation push inflation still higher," he said.
Beyond the expected December hike, Seki sees a gradual normalization path for the BOJ, with rate increases of about 25 basis points roughly every six months, assuming economic and price trends align with the central bank’s projections.
The terminal rate—where the tightening cycle would end—is projected to be in the 1.25% to 1.5% range by mid-2027, though risks tilt higher if inflation proves sticky.
BOJ projections place Japan’s nominal neutral rate somewhere between 1% and 2.5%.
On MUFG’s Japanese government bond strategy, Seki noted the bank has been cautiously rebuilding positions since the benchmark 10-year yield surpassed 1.65%. If yields rise above 2%, MUFG intends to accelerate its rebuilding, particularly in 10-year bonds, aligning with higher interest rates. The bank has substantial capacity to buy due to its currently restrained risk exposure.
This summary reflects reporting by Makiko Yamazaki, Miho Uranaka, and Tomo Uetake, with additional contributions from Takaya Yamaguchi and editing by Tomasz Janowski.
