Japan’s Pivot to 30-Year High Rates

Tokyo markets are bracing for a definitive shift in monetary policy this Friday, 19 December, as the Bank of Japan (BOJ) prepares to raise interest rates to levels not seen in three decades. The central bank is widely expected to lift short-term borrowing costs from 0.5 per cent to 0.75 per cent, marking the second hike of 2025. This move represents a critical juncture in Governor Kazuo Ueda’s mission to normalise Japan’s financial landscape after years of ultra-loose, unconventional easing. Despite facing external headwinds—including the spectre of US tariffs and domestic political transitions—the BOJ appears resolute in closing the chapter on near-zero rates.

The primary driver behind this hawkish pivot is the sustained inflationary pressure within the Japanese economy. Food costs have kept inflation hovering above the BOJ’s 2 per cent target for nearly four years, creating a macroeconomic environment that necessitates tighter policy. Policymakers are increasingly convinced that the country has entered a sustainable cycle where rising prices are supported by solid wage growth.

This sentiment is backed by data from the central bank’s branch offices, which anticipate that firms will continue to implement "bumper wage hikes" in the coming year to combat intensifying labour shortages. This wage-price spiral is the prerequisite the BOJ set for raising borrowing costs. Crucially, the government seems aligned with this trajectory. Finance Minister Satsuki Katayama recently stated, "There's no gap in the view on the economy" between the administration and the central bank, signalling political tolerance for the hike to 0.75 per cent.

While the rate hike signals economic normalisation, it also aims to address the fragility of the yen. A weak currency has historically boosted exporter profits but is now causing significant strain on households and retailers through imported inflation. Private think-tank Teikoku Databank reported that over 20,000 food and beverage items saw price increases this year—a staggering 64.6 per cent jump from 2024.

Governor Ueda faces a delicate balancing act. He is under pressure to drop hawkish hints to prevent a fresh sell-off of the yen, which would further inflate import costs. Government officials have indicated a readiness to intervene in currency markets to prevent "abrupt, sharp yen falls," suggesting a shared aversion to excessive currency depreciation. However, analysts warn that if the yen weakens too rapidly against the US dollar, it could accelerate inflationary risks, complicating the rate roadmap for 2026.

Looking ahead, global investors are focused on where the ceiling for Japanese rates might lie. BOJ policymakers have signalled an intent to move cautiously toward a "neutral" rate—a level that neither stimulates nor restricts the economy—estimated to be between 1 per cent and 2.5 per cent. This implies that while Friday’s hike is significant, it is likely just one step in a prolonged tightening cycle.

Kei Fujimoto, a senior economist at SuMi TRUST, notes that markets have largely priced in the December hike. He warns that combined pressures of a weak yen and higher interest rates "may push up consumer prices, corporate production costs and funding costs, potentially weighing on business sentiment." As Japan steps away from the era of cheap money, global capital markets must adjust to a landscape where the yen carry trade becomes increasingly expensive, and Japanese liquidity is no longer cost-free.