On July 31, 2024, a signboard reading “Bank of Japan” can be seen in Tokyo.
Kazuhiro Nogi | AFP | Getty Images
Japan’s central bank on Friday raised its economic growth forecast while keeping its key policy rate unchanged at 0.75% as it prepares for elections.
The Bank of Japan has revised upward its economic growth forecast for the fiscal year ending March 2026 from 0.7% in October 2025 to 0.9%, and also raised its GDP expansion forecast for fiscal 2026 from 0.7% to 1%.
The central bank expects Japan’s GDP to grow moderately as other countries return to growth, and the Bank of Japan expects a virtuous cycle of rising prices and wages, supported by government stimulus measures and accommodative financial conditions.
Ahead of a snap poll in which Prime Minister Sanae Takaichi is expected to strengthen his case for monetary easing and fiscal support, the central bank left the benchmark interest rate unchanged in an 8-1 vote after raising it to the highest level in 30 years in December.
The Bank of Japan said in a statement that Director Hajime Takada had proposed raising interest rates to 1%, saying that Japan’s price risks were skewed to the upside.
The central bank expects inflation to fall below its 2% target in the first half of this year and expects underlying inflation to “continue to rise moderately.”
Masahiko Lu, senior fixed income strategist at State Street Investment Management, said underlying inflation remains supported by wage growth and high service prices, which remain above 2%.
“The steady trend in inflation supports our view that the Bank of Japan’s normalization path will remain intact, albeit at a moderate pace,” he said.
Japan’s December inflation data released earlier in the day showed that the headline price increase rate was 2.1%, the lowest level since March 2022, but still above the Bank of Japan’s 2% target for the 45th consecutive month.
So-called “core-core” inflation, which excludes fresh food and energy prices, stood at 2.9% in December.
Japan will embark on a path to policy normalization in March 2024, abandoning the world’s last negative interest rate system and emphasizing raising interest rates conditional on a virtuous cycle of wages and prices.
However, the policy has come under political pressure from prominent figures, including Mr. Takaichi, who advocate easing interest rates to promote economic growth. Japan’s economy contracted more than initially expected in the third quarter, contracting by 0.6% from the previous quarter or 2.3% on an annualized basis.
Bank of Japan Governor Kazuo Ueda said on Friday that the Bank of Japan would continue raising interest rates if the economic and price outlook materializes, according to a translation of the governor’s remarks by Reuters.
Anxiety about bonds and the yen
Yields on Japanese government bonds have been rising despite the Bank of Japan’s monetary tightening, reaching multi-decade highs in the past month, causing capital outflows and a weaker yen. According to the Bank of Japan, this comes as real interest rates remain negative and fiscal instability is increasing.
Ueda said long-term interest rates were rising at a “fast pace” but the Bank of Japan was prepared to take “agile actions to deal with unusual developments.”
Takaichi had planned a record $783 billion budget for next year, which starts April 1, on top of last year’s $135 billion stimulus package aimed at supporting households struggling with rising costs of living.
Pressured by rising yields amid fiscal concerns, the yen depreciated sharply against the dollar toward the end of last year, and has fallen by about 4.6% since October 21, when Mr. Takaichi took office as prime minister, to the current level of 158.97 yen.
The weakness prompted Finance Minister Satsuki Katayama to warn against “unilateral” movements in the currency. Katayama reportedly told reporters in Washington last week that he expressed “deep concern” about the weaker yen, and that Treasury Secretary Scott Bessent shared his view about the “unilateral” depreciation of the Japanese currency.
He was quoted as saying on Friday that the bond market crash appeared to be receding and that he was closely monitoring financial markets with a “high sense of urgency.”
When asked if he agreed with Katayama’s opinion, Ueda said, “Volatility remains high,” and that he would “carefully examine trends.”
State Street’s Lu said the Bank of Japan’s base case is for one rate hike in 2026 and two hikes in 2027, for a final rate of 1.25%. If the yen breaks above the 160 yen level against the dollar, there is a possibility that interest rates will be raised twice this year, and once as early as April, bringing the final interest rate to 1.5%.
The terminal interest rate, also known as the neutral interest rate, is the interest rate that balances inflation and economic growth.
Separately, Takaichi on Friday dissolved Japan’s House of Representatives, and a snap general election is scheduled to be held on February 8.
