The Bank of Japan delivered its widely anticipated rate hike, yet the two dissenting votes have prompted investors to reassess where the tightening cycle might ultimately end.

The BOJ concluded its September 17-18 monetary policy meeting with a 7-2 majority decision to raise the policy rate by 25 basis points to 1.25%, in line with market consensus. However, the pair of opposing votes triggered a repricing of rate hike expectations, leading to a softer yen and a steeper yield curve.

Following this move, market expectations for additional tightening have cooled. According to Citi Research, the probability that the terminal rate settles at or below 2% has increased. Goldman Sachs noted that the statement delivered no clear signal of an accelerated pace of hikes, with financial conditions remaining accommodative. The process of policy rates converging toward the neutral rate is set to continue, though the pace is expected to stay gradual.

A 7-2 Vote with Dissent Drawing Market Attention

Policy board members Toichiro Asada and Ayano Sato voted against the hike, favoring the status quo. Citi Research highlighted that these two dissents underscore the clear resistance from the "reflationist" camp within the board, delivering an immediate impact on rate expectations—OIS pricing for future hikes pulled back right after the announcement.

Current market consensus points to another hike to 1.50% at the December meeting. However, Citi Research notes that the hurdle for back-to-back hikes remains elevated, with dollar and euro markets pricing roughly a 50% probability for their respective October meetings, making a similar move by Japan less likely.

Goldman Sachs, for its part, pointed out that the statement retains the language that "financial conditions are expected to remain accommodative even after the adjustment of policy rates," consistent with the wording used after the June hike, implying there is still room for rates to move toward neutral. The forward guidance also maintained the phrase that the Bank "will continue to raise the policy rate and adjust the degree of monetary accommodation," indicating intentions remain intact, though with no sign of acceleration.

Terminal Rate Ceiling Likely Locked Below 2%

This hike has pushed the policy rate to the lower bound of Goldman Sachs' estimated neutral range of 1.1% to 2.5%. Nevertheless, Citi Research argues that with neutral rate estimates around 2% or slightly higher, policy rates are gradually approaching that level, at which point the BOJ will need to more carefully assess market impacts and inflation trends, likely slowing the pace of hikes.

Political factors add another layer of uncertainty. Citi Research observed that despite the cabinet reshuffle, Economic and Fiscal Policy Minister Minori Kiuchi retained his post, signaling that the Takaichi administration's reflationary stance remains unchanged. Should this political environment persist, successors to board members Hajime Takata and Naoki Tamura may also lean toward reflationary views. In such a scenario, even if a slim 5-4 majority could still push through hikes, the bar would be significantly raised.

Citi Research believes that under these conditions, pushing the policy rate to 2% by July next year could become a priority objective, with the probability of the terminal rate being capped at or below 2% having clearly risen.

Upside Inflation Risk Assessment Unchanged

On the inflation front, the BOJ maintained its assessment since the July Outlook Report, identifying Middle East tensions, AI-related demand, and a weaker yen as the three major upside price risks, stating these factors "require continued monitoring."

The statement also retained the language from the June meeting that "underlying CPI inflation carries risks of deviating above the 2% price stability target."

Goldman Sachs said the key focus for Governor Kazuo Ueda's press conference will be whether the BOJ believes it has fallen behind the curve—a judgment that will directly influence the pace of future hikes.

The bank expects Ueda will not concede that policy is behind the curve, and his remarks on upside inflation risks, the neutral rate level, and the possibility of rate hikes triggering an economic slowdown are expected to show no significant shift from the July meeting.

Long-Term JGBs Present Compelling Value

On the rates strategy front, Citi Research maintains a positive view on long-dated Japanese government bonds. If inflation stabilizes around 2%, a 10-year JGB yield of 3% would be justified and attractive to real money investors. Should the policy rate fail to break above 2%, a 3% yield level would likely find support.

Citi Research also holds a constructive stance on super-long JGBs. Supply-demand dynamics remain solid, with no increase in super-long issuance next fiscal year, supporting a continued flattening trend in the yield curve. A stronger overseas market over the past week provides additional support. However, Citi Research believes that near-term market movements will be driven by rising short-to-medium term rates, with a rebound in super-long JGBs unlikely until next year at the earliest.

Additionally, the BOJ adjusted its "Climate Response Financing Operations," introducing a floating-rate mechanism with an overall program cap of 50 trillion yen and a single counterparty limit of 10 trillion yen.

Citi Research notes that with the current outstanding balance at approximately 25 trillion yen, growth will not stall in the short term, but the impact will gradually emerge as existing "Funds-Supplying Operations to Promote Bank Lending" measures mature.