Thoughts

August 29, 2025 | 14:55

Rate Decisions Based on… Everything?

Economist

Jennifer Lee

Senior Economist and Managing Director
Economics

(Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

(Read more)

It is all about inflation… for the most part.

That’s the case for the Bank of Japan, as it eyes an inflation rate that remains stuck above 2%. And, if its capital city is still seeing it, chances are the rest of the country is as well. Tokyo’s CPI inflation rate, a leading indicator for nationwide inflation, slowed 0.3 ppts to 2.6% y/y in August, while core CPI, which excludes fresh food, eased to a 2.5% y/y pace. This is encouraging, but the slower increases were mainly due to lower utility costs, as the government extended its power subsidies. Excluding fresh food & energy, core-core CPI eased only a smidgen, rising 3.0% y/y, still firmly above target and likely too hot for the Bank’s comfort. Policymakers also need to look at the broader economy to judge its ability to handle higher rates. The reports that were out this week were mixed. The jobless rate fell 0.2 ppts to a 5½-year low of 2.3%; consumer confidence edged up; but retail sales dropped 1.6%, as higher inflation is hurting real wage growth. That is another reason why earlier this month, the National Personnel Authority recommended a 3.6% base-pay increase for public employees this year—the largest hike in 34 years.

At the same time, all the back and forth with the U.S. trade deal must be weighing on business confidence. Although the broad strokes of the deal were released back on July 23, with Japan receiving a 15% tariff, there is still confusion about the details—and the details matter. Japan’s top trade negotiator cancelled his trip to D.C. this week because there was a disagreement about some key issues, likely around autos. The 15% tariff was supposed to include autos (down from 25%) and in return for that lower tariff, Japan would be investing $550 bln in America. Who decides where that money would go is not clear. In any event, the trade deal is still a large source of uncertainty, but at least there is a deal, which eases some of the downside growth risks. We are sticking with our September rate hike call.

Then there is the European Central Bank. It is still considering what to do with rates and, judging by the Minutes from the July meeting, there are plenty of differing opinions among policymakers. (See? It is not just the FOMC!) Although “most” saw inflation risks as being “broadly balanced” during the July meeting, “several” saw risks as being tilted to the downside, while “a few” felt they were tilted to the upside. Yes, it appears that all bases have been covered. And, the hawkish-leaning types have spoken up, including Finland’s Olli Rehn, who said that the economy “has been showing resilience and inflation is for now within the target”, so the ECB can take a step back and “reflect on the next steps”. Even the Bundesbank’s Joachim Nagel, as he presides over a still-struggling economy, declared “I don’t see many arguments that we should do more here on rates.” Plus, the secret sources who speak up anonymously stress that more weakness on the economy needs to be seen to prompt a September cut. Indeed, after what we’ve seen on the data front over the past couple of weeks, we now look for the ECB to hold off until December for its final rate cut.