Japan Targets 1.5% Rates by 2028

The era of ultra-loose monetary policy in Japan is decisively drawing to a close. Following a landmark move last week to raise borrowing costs to 0.75 per cent—a level unseen in three decades—the Bank of Japan (BOJ) is reportedly charting a course to push interest rates to 1.5 per cent by the end of Governor Kazuo Ueda’s term in early 2028. For global capital markets, this signals a fundamental shift in the liquidity landscape that has supported asset prices for years.

According to insights from former central bank board member Makoto Sakurai, the trajectory for Japan’s monetary normalisation is becoming clearer. The central bank is expected to execute three additional rate hikes over the coming years. This gradual tightening aims to dismantle the massive stimulus apparatus without choking off economic growth, provided the US economy remains resilient and domestic wage pressures persist.

The immediate focus for investors is mid-2026. Sakurai suggests that the next hike, pushing rates to 1.0 per cent, could materialise as early as June or July of next year. However, this is contingent upon external factors, specifically the strength of the US economy. If US growth underpins Japan’s export-heavy economy and domestic inflation remains stubbornly above the 2 per cent target, the BOJ may even attempt two hikes within the fiscal year beginning April 2026.

Conversely, if global economic uncertainty heightens, the central bank is likely to adopt a more cautious approach, potentially limiting action to a single hike in fiscal 2026 and delaying further tightening until 2027. This data-dependent approach highlights the BOJ’s desire to resume hiking at a pace of roughly once every six months, balancing the need for normalisation against the risks of a global slowdown.

As rates climb, the political dynamics in Tokyo are expected to become increasingly complex. The BOJ is navigating a delicate path towards the "neutral rate"—the theoretical level that neither stimulates nor cools the economy. While the bank officially estimates this range to be between 1.0 per cent and 2.5 per cent, insiders suggest the internal target for a neutral setting is likely around 1.75 per cent.

Stopping at 1.5 per cent would leave borrowing costs comfortably below this neutral level, providing the central bank with ammunition to cut rates in the future if necessary. However, approaching this threshold risks drawing ire from the administration. Premier Sanae Takaichi’s government, advised by reflationists, may push back against tightening measures that could dampen economic sentiment. Sakurai noted that the BOJ likely secured consent from the Premier and Finance Minister Satsuki Katayama for the recent move to 0.75 per cent, but warned that "as rates get closer to neutral, things could get complicated."

For foreign exchange traders, the Japanese Yen remains a puzzle. Despite the recent rate hike, the currency has faced selling pressure, a phenomenon Sakurai attributes to fiscal scepticism rather than monetary policy divergence. The administration’s expansionary fiscal policies and substantial spending packages intended to cushion households from rising living costs may ironically backfire by accelerating inflation.

The BOJ’s "tankan" survey reveals that corporate inflation expectations are becoming embedded, with projections hitting 2.4 per cent over the next five years. If the government’s fiscal looseness erodes market trust in Japan’s finances, bond yields could spike, driving further yen weakness. This disconnect between a hawkish central bank and a free-spending government creates a volatile environment for Japanese equities and global bond markets, as the traditional "safe haven" of the yen faces a crisis of confidence.