Bank of Japan Set to Raise Interest Rates Amid Global Economic Uncertainty
The Bank of Japan (BOJ) is widely anticipated to announce a rate hike this Friday, barring any significant market disruptions caused by U.S. President-elect Donald Trump's inauguration. This move will mark the first interest rate increase in over a year and raise short-term borrowing costs to levels not seen since the 2008 financial crisis.
The policy tightening reflects the BOJ's determination to gradually push up interest rates, currently at 0.25%, towards 1%. This level is deemed by analysts as neither overly restrictive nor overly stimulative for Japan's economy.
At its two-day policy meeting concluding on Friday, the BOJ is expected to raise its short-term policy rate to 0.5%, assuming Trump's inauguration speech and executive orders do not destabilize financial markets, according to sources speaking to Reuters. In its quarterly outlook report, the board is also likely to revise its inflation forecasts upward, based on growing expectations that wage growth will continue to support Japan's progress towards the bank's 2% inflation target.
A rate hike by the BOJ would be the first since July 2016, when the move sent shockwaves through global markets along with weak U.S. jobs data. To mitigate the risk of a similar market reaction, the BOJ has diligently prepared markets through clear signals from Governor Kazuo Ueda and his deputy last week that a rate increase was imminent. These signals led to a rebound in the yen as markets priced in an approximately 80% probability of a rate hike on Friday.
There were also hints of near-term action in December. Although the BOJ refrained from raising rates at its December 18-19 meeting, hawkish board member Naoki Tamura advocated for an increase. Meeting minutes revealed that some of his colleagues also believed conditions were ripe for an impending rate hike.
In light of the near certainty of a policy tightening this week, market focus has shifted to Ueda's post-meeting briefing for insights into the timing and pace of subsequent rate increases. With inflation exceeding the BOJ's 2% target for nearly three years and import costs elevated due to the weak yen, Ueda is likely to emphasize the policymakers' determination to continue raising interest rates.
However, there are reasons for caution. Despite the International Monetary Fund's recent upgrade in its global growth forecast for 2025, Trump's policies pose risks to market stability and create uncertainty for Japan's export-dependent economy. Domestic political uncertainty could also increase, as Prime Minister Shigeru Ishiba's minority coalition faces challenges in passing the budget through parliament and winning an upper house election slated for July.
BOJ policymakers are also mindful of the economic damage caused by past ill-timed rate hikes. The BOJ ended quantitative easing in 2006 and raised short-term rates to 0.5% in 2007, provoking a barrage of political criticism for delaying the end of deflation. In response to the 2008 financial crisis, the BOJ slashed rates from 0.5% to 0.3% in October 2008 and further to 0.1% in December of that year, as Japan plunged into recession. Since then, various unconventional measures have kept borrowing costs near zero.
"Japan has experienced persistently low growth, inflation, and interest rates. Therefore, policymakers, investors, and the business community remain skeptical about the possibility of a permanent escape from these conditions," noted Jeffrey Young, Chief Executive Officer of DeepMacro. "The BOJ will need to carefully explain its rationale for raising rates and its intention to gradually move away from the extraordinary monetary policy it has employed."