Bank of Japan is poised to raise rates to a 30-year high despite economic weakness
Bank of Japan (BOJ) Governor Kazuo Ueda makes a speech signal at the budget committee meeting held in the lower house of parliament in Tokyo, Japan, on Tuesday, December 9, 2025. Ueda said the recent rate of increase in Japan’s long-term bond yields was “a bit fast” but added that long-term yields should in principle be determined by the market. Photographer: Kiyoshi Ota/Bloomberg via Getty Images
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Japan’s central bank kicked off its final policy meeting of the year on Thursday with expectations it will raise benchmark interest rates to a 30-year high as it seeks to maintain the policy normalization it laid out last year.
In the decision to be made on Friday, rates can be expected to be increased to 0.75%, the highest level since 1995, while data from LSEG shows the probability of the Bank of Japan raising interest rates at 86.4%.
The rate hike will most likely strengthen the yen against the dollar and control inflation, which has been above the BOJ target for 43 months. However, the weak Japanese economy, which shrank in the third quarter, could further slow down.
Revised GDP figures It showed that Japan’s economy contracted more than initially forecast in the three months to September, shrinking by 0.6% on a quarterly basis and 2.3% on an annual basis.
While it is thought that an interest rate increase is almost certain, experts stated that the market will focus more on the BOJ’s comments after the decision.
Gregor MA Hirt, chief global multi-asset investment officer at Allianz Global Investors, said in a note on Tuesday that the market reaction will depend on the nuances of the BOJ’s communication.
Signals around the neutral or final rate that balances inflation and economic growth and comments on yen weakness will be some of the things to watch out for.
Governor Kazuo Ueda It is said that The final interest rate was difficult to predict as the central bank earlier this month pegged it at between 1% and 2.5%.
“Unfortunately, the neutral interest rate is a concept that we can only estimate within a fairly wide range,” Ueda said in his speech to the Japanese parliament. he said.
While efforts are being made to narrow the interest rate band, Ueda said the BOJ should direct monetary policy without clarity on where exactly the neutral interest rate is.
MFS Investment Management fixed income research analyst Carl Ang said an updated forecast on neutral interest could be shared after the Friday meeting.
Speed of interest rate increases
Japan began policy normalization last year, abandoning the world’s only negative interest rate regime since 2016. Since then, the BOJ has consistently maintained its stance of gradually increasing interest rates.
Investors will be waiting for BOJ’s comments on the pace of future interest rate hikes.
Dutch bank ING said in a note on Wednesday that the market largely expects another interest rate hike in June 2026, but it is more likely that the BOJ’s next rate hike will occur only in October.
In contrast, Bank of America predicts an increase in June. However, if the yen weakens rapidly, we do not completely rule out the BOJ pushing it forward to April. BofA analysts expect the BOJ to raise its final interest rate to 1.5% by the end of 2027.
While MFS’s Ang said there were risks to Japan’s path to policy normalization, including a US economic slowdown and rising China-Japan tensions, he said it would take a “material shock” to move the BOJ away from its interest rate orbit.
Bonds and forex view
Allianz’s Hirt said the central bank had not directly addressed currency concerns but that if Ueda commented directly on the yen’s weakness it would be seen as “a line in the sand”.
The yen has been trading around 154-157 against the dollar since November and has lost more than 2.5% since Prime Minister Sanae Takaichi, an advocate of looser monetary policy, took office in October.
A higher interest rate would also increase bond yields and borrowing costs for the Japanese government, which has announced the biggest stimulus package since the Covid-19 outbreak as it seeks to stimulate the economy.
Nikkei reported earlier this month that Japan’s borrowing costs could double if benchmark interest rates rise from the current 2% to 2.5%. The yield on 10-year Japanese government bonds is near 18-year highs at 1.971%.
A 2.5 percent yield means paying interest for the Japanese government will jump 16.1 trillion yen in fiscal 2028 compared to 7.9 trillion yen in fiscal 2024.
Finance minister Satsuki Katayama takes into account fiscal concerns and possible finance ministry intervention in forex markets did not exclude MFS’ Ang expects the yen to stay between 150 and 160 next year.
