The Bank of Japan Raises Rates in an Unexpected Move: What to Expect Next?

Bank of Japan surprises markets with interest rate hike

In a largely unexpected move, the Bank of Japan has raised interest rates and unveiled a detailed plan to slow down its massive bond purchases, taking another step towards gradually phasing out a decade of huge stimulus.
This decision, contrary to market expectations of unchanged rates, brings its short-term reference rate to levels not seen since 2008.

The yen initially surged by 0.8% to a three-month high of 151.58 against the dollar immediately after the announcement, although it later reversed those gains and weakened against the greenback.
Japanese bank stocks led the Nikkei’s rally, as higher rates are expected to improve lending margins and increase investment income for banks.

Japan’s shift to a more restrictive monetary policy stands in stark contrast to the broad trend of interest rate cuts by other major economies, with the Federal Reserve increasingly likely to cut rates in September as US inflation pressures ease.
The Fed will announce its decision for July tonight, possibly providing new guidance for September.

Bank of Japan’s interest rate hike and bond purchase reduction plan

The Japanese central bank raised the reference interest rate to “about 0.25%” from the previous range of 0% to 0.1% and outlined its plan to gradually reduce the bond purchase program.
The quantitative tightening (QT) will roughly halve monthly bond purchases from the current 6 trillion yen ($19.6 billion) to 3 trillion yen ($19.6 billion) in the January-March 2026 period.

The BoJ specified that the rate hike was based on the belief that wage increases were expanding, pushing companies to pass on higher labor costs to service prices.
Import prices are accelerating again despite a recent moderation, highlighting the need to be vigilant against excessive inflation.

Given that real interest rates are significantly low, the BoJ will continue to raise rates and adjust monetary accommodation if the economy and prices move in line with its latest projections.
The quarterly outlook report confirmed the forecast made in April that inflation would remain around 2% until fiscal year 2026.

It’s worth noting that in 2016, the BoJ lowered the main interest rate below zero in an attempt to stimulate the country’s stagnant economy.
Negative rates require individuals to pay to deposit money in banks, used by several countries to encourage spending rather than keeping money in deposit accounts.

Anticipating higher rates in Japan

Stefan Angrick, senior economist at Moody’s Analytics, commented on the Japanese move without surprise, noting that the rate hike was widely expected after national media anticipated the decision.
Official data showed Japan’s economy contracted by 2.9% annually from January to March, while consumer prices rose 2.6% in June, lower than expected.

Despite stagnant consumer spending, monetary officials sent a decisive signal by raising interest rates and allowing a more gradual reduction of the balance sheet.
This decision will have repercussions on global financial markets, given the yen’s status as a major carry trade currency.

Analysts will closely watch how Japan’s restrictive monetary policy will impact Japanese government bond yields and the substantial amount of foreign debt held by Japanese investors.
With higher yields domestically, a sell-off of US and other countries’ bonds could be triggered.