This week, the Bank of Japan will release its quarterly economic report and policy statement. Prior to this highly anticipated interest rate decision, the market is currently engaged in intense speculation. Will the Bank of Japan surprise the market once again?
UBS believes that this week presents a good opportunity for the Bank of Japan to take action, as they believe it is time to adjust their policies.
On July 21st, a team led by UBS economist Masamichi Adachi pointed out in a report that most people may have misunderstood the dovish stance of Bank of Japan Governor Haruhiko Kuroda. Contrary to the majority of market expectations, UBS believes that given the current economic conditions, the Bank of Japan may adjust its Yield Curve Control (YCC) policy this week. If UBS's prediction turns out to be true, the Bank of Japan's surprise move could once again &#34;shock the market&#34;:
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According to the latest survey by Bloomberg, only 18% of economists believe that the Bank of Japan will adjust or cancel its YCC policy on the yield curve this week. 82% of economists expect that the policy will remain unchanged at this meeting, and 40% predict that there will be no adjustments within the year.
The survey also shows that if the Bank of Japan takes action this week, about 60% of the market will be surprised.
We believe that most people in the market have misunderstood the intentions of the Bank of Japan. The Bank of Japan currently has sufficient reasons to judge that inflation has risen enough to offset the impact of adjusting the YCC policy on the bond market.
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In June, Japan's overall inflation rose to 3.3%, surpassing the United States for the first time in eight years. The core inflation rate &#34;soared&#34; to 4.2%, reaching its highest level since September 1981. UBS believes that Japan's CPI is facing significant downward pressure, and whether the Bank of Japan can achieve a sustained inflation target of over 2% in the next few years depends on whether the inflation rate will rise again after falling:
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According to our forecast, Japan's inflation rate will decline in the next few months and fall below 2% by the middle of next year. The decline in import prices indicates that CPI inflation is facing significant downward pressure.
Whether the Bank of Japan can achieve the 2% inflation target in the next few years depends on whether inflation can rise again after falling. It is expected that the inflation rate will fall below 2% by the middle of next year. In other words, we are concerned about whether the shape of the inflation path will be U-shaped (indicating a reacceleration of inflation) or L-shaped (indicating no reacceleration if there is no further decline).
We are also paying attention to the output gap (i.e., actual GDP growth) and wage prospects after next year. According to our forecast, wage growth will accelerate significantly in this fiscal year, then slow down in the fiscal year 2024, and rebound in the fiscal year 2025. We lack confidence in the current pace of wage growth.
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According to UBS's report, the yield curve in Japan is gradually becoming smoother and the functionality of the bond market has improved. However, from a longer-term perspective, the market functionality has deteriorated. July is the best time to initiate the normalization of Japan's monetary policy.
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UBS also points out that if they misjudge the policy of the Bank of Japan and the Bank of Japan continues to maintain the status quo this week, what impact will it have?
This indicates that under the leadership of Governor Haruhiko Kuroda, the Bank of Japan, led by Masayoshi Amamiya, has a more dovish assessment of potential inflation and less concern about the normalization of market functionality. In this policy stance, the yen and bond yields will continue to decline, while stock and real estate prices will rise.
UBS believes that although the above results seem more favorable for Japan to achieve sustainable inflation targets, there will be higher risks of market and economic turbulence when the Bank of Japan shifts towards policy normalization.

UBS believes that the current inflation level in Japan is sufficient to offset the impact of adjusting the YCC policy on the bond market. If the Bank of Japan is more concerned about the functionality of the bond market, July is the best time to start normalizing Japan's monetary policy.

Is the Bank of Japan going to take action this week? UBS: The market thinks it won't, but we believe it will!