The Bank of Japan is definitely going to raise interest rates in December! Vanguard Group warns: traders are seriously misjudging the ultimate point of interest rates in Japan.

Vanguard Group has stated that despite traders are heavily betting on the Bank of Japan raising interest rates this month, they are still underestimating a risk: that Japanese interest rates need to rise significantly further to curb inflation. The yield on Japan's two-year government bonds has recently climbed to over 1%, reaching the highest level since 2008, as investors bet that Bank of Japan officials led by Governor Haruhiko Kuroda will raise benchmark borrowing costs at the meeting on December 18-19. However, after years of continued loose monetary policy, despite Japan's inflation expectations approaching their strongest level since 2004, its interest rates still remain far below those of G10 countries. Vanguard Group's global rate manager Roger Hallam, who oversees $1.1 trillion in assets, said in an interview on Thursday, "The market underestimates how high Japan's neutral interest rate needs to reach to alleviate inflationary pressures, so reducing Japanese government bonds is the right choice." "We still believe the Bank of Japan will continue to normalize its policies and will raise interest rates in December." Kuroda stated this week that the neutral interest rate the level at which monetary policy is believed to be neither restrictive nor stimulatory is currently only estimated within a very broad range. The Bank of Japan had previously stated that the neutral interest rate is between 1% and 2.5%. Its current policy rate is 0.50%. Hallam noted that Vanguard Group is reducing Japanese government bonds in the short to medium part of the yield curve relative to the fund benchmark. Key members of Prime Minister Taro Aso's government will not hinder the rate hike, prompting swap traders to increase their expectations of a rate hike. They currently expect a tightening of about 22 basis points at the end of the Bank of Japan meeting on December 19, up from about 14 basis points a week ago. Vanguard Group's expectation of a rate hike by the Bank of Japan also supports its view that short-term rates in Japan will underperform long-term rates. This has been the view held by the company and its peers, including Sumitomo Mitsui Trust Bank and T. Rowe Price International, in recent months. Hallam stated that the normalization of Bank of Japan's policy "often flattens outwards from the front end." "Considering the relatively steep yield curve, the flattening trade between the belly and the long end of the curve is actually quite attractive." Although the spread between Japanese five-year and thirty-year government bonds narrowed by about 35 basis points from September to October, this spread has recently widened by around 15 basis points from its October low point.