The Bank of Japan (BOJ) has taken a significant step in shifting away from its long-standing monetary stimulus policies. For only the second time in nearly two decades, the BOJ unexpectedly raised interest rates. Furthermore, the central bank launched a detailed plan to gradually scale back its massive bond-buying program. These actions represent a major move towards phasing out the substantial monetary support the BOJ has maintained for over a decade.
Raising short-term rates, hinting at further tightening
The decision, which defied market expectations for the BOJ to maintain its current policy, raised the bank’s short-term policy rate to levels not seen since 2008.
“If data shows economic conditions are on track, and if such data accumulates, we would of course take the next step,” BOJ Governor Kazuo Ueda told a news conference, hinting at the possibility of another rate hike later this year.
Gradual approach to adjusting stimulus, quantitative tightening plan
Ueda highlighted that the gradual approach to adjusting the degree of stimulus would help avoid the need for abrupt changes in the future. The BOJ’s board voted 7-2 to raise the overnight call rate target to 0.25 percent from the previous range of 0-0.1 percent.
The central bank also announced a quantitative tightening (QT) plan that would roughly halve its monthly bond purchases to 3 trillion yen ($19.6 billion), down from the current 6 trillion yen, starting in January-March 2026.
Concerns over inflation overshoot
Ueda cited the risk of inflation overshooting the Bank of Japan’s projection due to rising import costs from a weaker yen as a key factor behind the rate hike. “If the economy and prices move in line with our projection, we will continue to raise interest rates,” he said.
Market reaction
The yen strengthened to 150.88 against the dollar following Ueda’s comments, reflecting the market’s reaction to the BOJ’s policy shift. HSBC’s Chief Asia Economist, Fred Neumann, described the BOJ’s move as a “decisive signal” amid sluggish consumer spending, and said it paves the way for further monetary policy normalization.
Outlook and warnings
The central bank’s decision was based on its view that wage hikes were broadening and leading firms to pass on higher labor costs through increases in services prices. The Bank of Japan also cited the need to be vigilant about the risk of an inflation overshoot.
In its quarterly outlook report, the BOJ roughly maintained its April projection that inflation would stay around 2 percent through fiscal 2026. However, it warned that inflation may be more affected by yen moves than before, given companies were already raising prices and wages.
Shifting global monetary landscape
The BOJ’s policy shift comes as the U.S. Federal Reserve appears poised to start cutting interest rates, reversing an aggressive tightening cycle that had driven up the dollar and caused a painful yen sell-off for Japan.
For more economy news, click here.
