The Bank of Japan is approaching a critical juncture in its interest rate normalization process.

On Tuesday, according to Reuters citing three people familiar with the matter, the central bank may signal this month that underlying inflation has broadly reached its 2% target. This statement carries more symbolic weight than actual policy action, but it would significantly strengthen market pricing for a December rate hike—overnight index swaps have already pushed that probability up to 80%.

The sources said the Bank of Japan has already begun emphasizing in its policy communications the need to anchor underlying inflation near the 2% target as a basis for judging the pace and timing of subsequent rate hikes. Recent data such as Tokyo consumer inflation and the central bank's quarterly "Tankan" corporate survey are strengthening policymakers' confidence that underlying inflation has "broadly reached" the target, and the central bank may formally confirm this judgment in the quarterly report released after its October 29-30 meeting.

If this signal materializes, it would mark a landmark shift in the Bank of Japan's characterization of its inflation target, clearing the prerequisite for another rate hike in December. The lesson from September's hike—when the yen fell instead of rising—still lingers: policy actions lacking clearer guidance on the pace of tightening struggle to reverse yen weakness in the face of the U.S.-Japan interest rate differential. The gap between signal and action is precisely the core tension the Bank of Japan currently faces. The sources stressed that the data is sufficient to support the central bank publicly confirming "target met," but not enough to persuade a majority of board members to hike back-to-back this month; government representatives also applied rare pressure, urging the central bank to carefully assess the cumulative effects of previous rate hikes.

From "Will Meet" to "Broadly Met": A Key Step in Wording

In the quarterly report released in July this year, the Bank of Japan's language was still that underlying inflation would reach a level consistent with the 2% target at some point before March 2028. By the September meeting minutes, some board members had already said underlying inflation was "fairly close" to 2%, or would reach it "soon." If "broadly met" is formally confirmed this month, it would complete the wording shift from "forward-looking expectation" to "current-status confirmation."

One source said "overall, price developments are in line with the Bank of Japan's projections," meaning underlying inflation is now roughly near the target; another said "inflation expectations remain elevated but have not heated up sharply." Such wording leaves room for a December rate hike while deliberately downplaying the urgency of immediate action.

80% Pricing, and Funds Still Shorting the Yen

Overnight index swaps show that market-implied probability of a December rate hike has risen to 80%. After the two hikes in June and September, the market has broadly priced the Bank of Japan at a pace of "one hike per quarter."

Signals from the flows side are more complex. U.S. Commodity Futures Trading Commission (CFTC) data shows that in the week ended September 29, leveraged funds turned net short on the yen again, with bearish bets totaling about 210 billion yen (roughly $1.3 billion).

Against the backdrop of consecutive rate hikes by the central bank, repeated warnings from the Japanese government about excessive yen depreciation, and U.S. Treasury Secretary Bessent publicly discussing "the desirability of a strong yen," speculative funds still chose to short—indicating that what the market is really trading is whether the U.S.-Japan interest rate differential can narrow quickly, not whether the central bank will continue hiking.

Data Enough for a Signal, Not Enough for Back-to-Back Hikes

Although the "Tankan" survey shows corporate inflation expectations remain high, they are moving sideways and have not heated up in a way that demands an immediate policy response, which to a considerable extent has lifted the burden of consecutive rate hikes this month from the central bank. The 7-2 vote at the September meeting already exposed internal divisions, with two dovish members casting dissenting votes.

The government's stance further compresses the room for action this month. The September meeting minutes show that a Cabinet Office representative rarely urged the central bank to "carefully examine the cumulative effects of past rate hikes" and suggested incorporating estimates of the neutral rate into consideration. This statement temporarily cooled market expectations for consecutive rate hikes in October, and the yen subsequently fell below the 158 mark.

The Yen's Constraint

After the September rate hike, the yen fell rather than rose against the dollar, dropping more than 2% in a single week, with the dollar-yen pair once rising to 157.53. The yield on Japan's 10-year government bonds had previously touched 3%, the first time since 1996. Sources noted that renewed yen weakness could increase pressure on the central bank to hike in October, but the pullback in U.S. rate hike expectations this month partially offsets that pressure, raising the probability that the Bank of Japan will hold steady in October.

The wording of the quarterly report after the October 29-30 meeting will be the next key signal for judging whether a December rate hike can materialize.