Kazuo Ueda, the governor of the Bank of Japan (BOJ), announced a pivotal decision during a financial affairs committee meeting held at the lower house of parliament in Tokyo. In a move that marks a significant shift in Japan’s monetary policy, the BOJ raised its short-term benchmark interest rates by 25 basis points, bringing them to 0.75%. This level represents the highest rate seen in three decades, signifying a major step in the country’s efforts towards policy normalization.
This rate hike has prompted a notable reaction in the financial markets, with a sell-off in government bonds observed immediately following the announcement. The yield on the country’s 10-year Japanese government bonds surged by approximately 5 basis points to reach 2.019%, while the yield on the 20-year bond climbed 3 basis points to 2.975%. Both yields mark their highest values since 1999. In the forex market, the yen weakened by 0.25% against the dollar to trade at 155.92, while the benchmark Nikkei 225 stock index experienced a 1.28% increase.
Japan’s journey towards policy normalization began last year with the abandonment of a negative interest rate policy that had been in effect since 2016. The BOJ has since signaled its intent to gradually lift interest rates to foster a sustainable economic environment characterized by a “virtuous cycle” of rising wages and prices. Presently, inflation has consistently surpassed the bank’s 2% target for 44 consecutive months, with November data reflecting a consumer price growth rate of 2.9%. However, the trend of high inflation has simultaneously pressured real wages, which have been on a decline for the past 10 months, as reported by labor ministry statistics.
The Bank of Japan’s outlook suggests that while core inflation—excluding fresh food prices—may decelerate below the intended 2% target from April to September 2026, this could be attributed to a slower rise in food prices along with government interventions aimed at alleviating price pressures. The central bank acknowledged concerns regarding the potential exacerbation of economic downturns as a result of these higher rates. Recent revisions to GDP data for Q3 revealed a greater-than-anticipated contraction of the economy, with a 0.6% decline quarter-on-quarter and a striking 2.3% drop on an annualized basis.
Despite these challenges, the BOJ expressed optimism regarding corporate profitability, predicting that firms would continue to raise wages in the coming year. The central bank emphasized its belief that a moderate balance between wage increases and price hikes could be sustained, which would contribute to achieving the inflation target.
The current wave of yield increases poses risks, notably the potential for higher borrowing costs for the Japanese government, which already grapples with the world’s highest debt-to-GDP ratio, estimated at nearly 230%. However, these rising yields may provide some support for the yen, which has remained volatile, fluctuating between 154 and 157 against the dollar since November.
Economic analysts, such as Shigeto Nagai from Oxford Economics, project that the BOJ will likely make another rate hike in mid-2026, potentially reaching a terminal rate of around 1%. This terminal rate is considered the equilibrium point that balances inflation pressures and economic growth, avoiding overheating or stagnation.
The ongoing tension within the government regarding monetary policy is notable, particularly as Prime Minister Sanae Takaichi, who had been a proponent of looser monetary policies, has softened her stance since taking office in October. Analysts suggest that ongoing inflationary pressures and the ensuing cost-of-living crisis may have swayed Takaichi’s acceptance of the recent rate hike. Moreover, the Japanese cabinet has recently approved a substantial stimulus package of 21.3 trillion yen ($135.5 billion) aimed at rejuvenating the struggling economy and providing relief to consumers grappling with inflationary pressures.
