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We revise our 2026 and 2027 GDP growth forecasts to 0.9% and 1.0%, respectively, from 0.5% and 0.5% currently. Our CPI inflation forecast is maintained at 1.8% for 2026 but revised down to 1.5% for 2027. The 2Q GDP release on August 17, while lower than consensus, was in line with our expectations at 1.1% qoq saar. The 1.1% growth followed a strong 1.9% expansion in 1Q and remained broadly in line with Japan’s average growth rate over the past five years. Our annual forecast revisions, to a large extent, take into account the government’s recent approval to cut the food consumption tax from 8% to 1%, effective April 2027. Food has a large weight in Japan’s CPI, and reducing the tax rate on food products to 1% is estimated to lower 2027 CPI inflation by a significant 1ppt. Given that food is a daily necessity and a substantial portion of the tax savings is likely to be saved, we estimate that the boost to 2027 GDP growth will be modest, at around 0.2ppt.
We expect the Bank of Japan to accelerate the pace of rate hikes to 25bps every 3-4 months, from once every six months currently, with a higher terminal rate of 1.75% in the current tightening cycle. We bring forward our expected timing of the next BOJ rate hike to September and expect another two moves in 1Q27 and 2Q27, respectively, taking the overnight call rate to 1.75% by mid-2027. The latest BOJ communication has become more hawkish, while the government also appears less opposed to an early hike, further increasing the likelihood of a September move. Various measures suggest that underlying inflation has reached a stable 1.5-2.0% range (CPI excluding fresh food, energy and institutional factors: 2.0%; trimmed-mean CPI: 1.6%), pointing to a neutral interest rate of around 2%. Our JPY rates forecasts have also been revised higher accordingly.
Market implications
Conditions are aligning for a different take on JPY assets. For an extended period, market participants understand that yen weakness and elevated CPI are tolerated, with the BOJ not willing to accelerate tightening beyond a pace of 25bps every six months. That has changed with dual interventions by the BOJ and the US Treasury and local reports suggesting less resistance from Takaichi’s administration towards rate hikes. Accordingly, we think that the Fed / BOJ monetary policy divergence should not be underestimated and should be supportive of yen strength over the medium term. Moreover, we think that the USD could be bogged down by political risks (Trump’s approval rating are plummeting) and increasing fiscal worries. Below, we lay out four scenarios on how we think about the yen and JPY rates, keeping to a skew towards yen strength and higher front/belly JPY rates.
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