Kazuo Ueda, governor of the Bank of Japan (BOJ), gestures to speak during a budget committee session at the lower house of parliament in Tokyo, Japan, on Tuesday, Dec. 9, 2025. Ueda said the recent pace of increases in Japans long-term bond yields is “somewhat fast,” while adding that long-term yields should be determined by the market in principle. Photographer: Kiyoshi Ota/Bloomberg via Getty Images
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Japan’s central bank on Thursday kicked off its last policy meeting of the year, with expectations that it will raise benchmark interest rates to their highest in 30 years, as it seeks to move ahead with policy normalization set forth last year.
The decision, due Friday, could see rates raised to 0.75% — highest since 1995 — with data from LSEG showing an 86.4% probability of a hike by the Bank of Japan.
A rate hike will likely strengthen the yen against the dollar, and contain inflation, which has run above the BOJ’s target for 43 straight months. But it could further slow a weak Japanese economy that contracted in the third quarter.
Revised GDP numbers showed that Japan’s economy in the three months through September contracted more than initially estimated, shrinking 0.6% quarter on quarter, and 2.3% on an annualized basis.
With a rate hike almost certain, experts said that market focus will be more on the BOJ’s commentary after the decision.
Gregor MA Hirt, global multi-asset chief investment officer at Allianz Global Investors, said in a Tuesday note that the market reaction will depend on the nuances of the BOJ’s communication.
Signals around the neutral, or terminal, rate — one that balances inflation and economic growth — and comments on yen weakness will be some of the things to look out for.
Governor Kazuo Ueda reportedly said earlier this month that it was difficult to estimate the terminal rate, with the central bank pegging it at 1% to 2.5%.
“Unfortunately, the neutral rate of interest is a concept for which we can only produce an estimate with quite a wide range,” Ueda told Japan’s parliament.
While efforts have been made to narrow the rate range, Ueda said that the BOJ must guide monetary policy without clarity on where exactly the neutral rate lies.
Carl Ang, fixed income research analyst at MFS Investment Management, said that an updated estimate on the neutral rate may be shared after the Friday meeting.
Pace of rate hikes
Japan embarked on policy normalization last year, abandoning the world’s only negative interest rate regime that had been in place since 2016. Since then, the BOJ has been consistently maintained it’s stance of gradually raising rates.
Investors will be looking out for the BOJ’s commentary around the pace of future rate hikes.
Dutch bank ING said in a note on Wednesday that while the market largely expects another hike in June 2026, it is more likely that the BOJ will next raise rates only in October.
In contrast, Bank of America estimates a hike in June, while not entirely discounting the BOJ fast-forwarding it to April if the yen weakens rapidly. BofA analysts expect the BOJ to bring the terminal rate to 1.5% by end 2027.
While MFS’ Ang said there were some risks to Japan’s policy normalization path, including a U.S. economic slowdown and escalating China-Japan tensions, it would take a “material shock” to veer the BOJ away from its rate trajectory.
Bonds and forex outlook
The central bank has not directly addressed foreign exchange concerns, but should Ueda comment on the yen’s weakness directly, it would be seen as a “line in the sand,” Allianz’s Hirt said.
The yen has been trading around the 154-157 against the dollar since November, having weakened over 2.5% since Prime Minister Sanae Takaichi, a proponent of looser monetary policy, took office in October.
Takaichi during her leadership contest had staunchly opposed rate hikes by the BOJ, but has since softened her stance.
A higher rate will also push up bond yields and borrowing costs for the Japanese government, which has unleashed its largest stimulus package since the Covid-19 pandemic as it tries to boost the economy.
Nikkei earlier this month reported that Japan’s borrowing costs could double, if benchmark yields rise to 2.5% from its current level of about 2%. Yields on 10-year Japanese government bonds are hovering near 18-year highs, last at 1.971%.
Yields at 2.5% would mean interest payments for the Japanese government will jump to 16.1 trillion yen in its 2028 fiscal year compared to 7.9 trillion yen in fiscal 2024.
Accounting for fiscal concerns and possible finance ministry intervention in forex markets, something that finance minister Satsuki Katayama has not ruled out, MFS’ Ang expects the yen to stay between 150 and 160 next year.
