Bank of Japan Set to Hike Interest Rates
The Bank of Japan (BOJ) is widely anticipated to raise interest rates at its policy meeting concluding on Friday. This move, barring any unexpected market shocks during U.S. President-elect Donald Trump's inauguration, would mark the first rate increase since July 2022.
The tightening of monetary policy underscores the BOJ's commitment to gradually push interest rates higher, currently at 0.25%, toward 1%. This level is considered by analysts to be neither overly stimulative nor contractionary for Japan's economy.
At the two-day meeting, the BOJ is expected to lift its short-term policy rate to 0.5%, sources say. This action is contingent on the absence of significant disruptions to financial markets caused by Trump's inaugural address and executive orders.
In its quarterly outlook report, the central bank is also expected to upgrade its inflation projections amid increasing prospects that rising wages will support a sustainable path toward the BOJ's 2% inflation target.
A hike by the BOJ would follow a similar move in July 2022, which, combined with weak U.S. employment data, sparked market volatility and a global sell-off in early August. To mitigate the risk of a similar market reaction, the BOJ has taken steps to prepare markets, with clear signals from Governor Kazuo Ueda and his deputy.
The market now assigns an approximately 80% probability of a rate increase on Friday. Hints of near-term action were also evident at the December 2022 policy meeting, where hawkish board member Naoki Tamura advocated for an immediate rate hike, supported by some of his colleagues.
Given the near-certainty of a rate hike this week, market focus will shift to Ueda's post-meeting briefing for guidance on the timing and pace of subsequent rate increases. With inflation persistently above the BOJ's 2% target for almost three years and an elevated yen keeping import costs high, Ueda is likely to reiterate policymakers' commitment to raising rates further.
However, caution remains warranted. While the International Monetary Fund has raised its global growth forecast for 2025, Trump's policies carry the potential to destabilize markets and increase uncertainty for Japan's export-reliant economy. Domestic political uncertainty could also intensify, with Prime Minister Shigeru Ishiba's minority coalition facing challenges in passing budget legislation and winning the upper house election in July.
The economic damage caused by past ill-timed rate hikes remains a concern for BOJ policymakers. The BOJ's decision to exit quantitative easing in 2006 and raise rates to 0.5% in 2007 drew significant political criticism for delaying an exit from deflation.
The BOJ subsequently cut rates from 0.5% to 0.3% in October 2008 and then to 0.1% in December of that year, as the global financial crisis pushed Japan into recession. Various unconventional measures have kept borrowing costs near zero since then.
"Japan has experienced persistently low growth rates, inflation, and interest rates in the past," noted Jeffrey Young, CEO of DeepMacro. "Policymakers, investors, and businesses will therefore continue to question whether we have truly broken free from this pattern. The BOJ will need to carefully articulate its rationale for raising rates and its intention to move away from the extraordinary policy measures it has implemented."