Bank of Japan Holds Rates at 0.75% as Bond Yields Rise and Yen Weakens Amid Political Pressure

TLDR:

• BOJ held rates at 0.75% in an 8-1 vote, with one member pushing for a hike to 1%, citing price risks.
• The growth forecast was raised to 0.9% for FY2026 as inflation stayed above the 2% target for 45 consecutive months.
• The yen fell 4.6% since October to 158.97 per dollar, prompting warnings from Finance Minister Katayama.
• Bond yields hit multidecade highs despite tightening, with Ueda ready for nimble action on volatility.

The Bank of Japan maintained its benchmark interest rate at 0.75% during Friday’s policy meeting while upgrading economic growth forecasts. 

The decision comes amid market volatility triggered by Prime Minister Sanae Takaichi’s call for snap elections next month. 

Governor Kazuo Ueda reaffirmed the central bank’s commitment to gradual rate increases if economic conditions support such moves. The board voted 8-1 to hold rates steady after raising them to a 30-year high in December.

Growth Forecasts Rise as Inflation Remains Above Target

The central bank raised its economic growth projection for the fiscal year ending March 2026 to 0.9% from 0.7%. The outlook for fiscal 2026 also increased to 1% from the previous 0.7% estimate. 

These upgrades reflect expectations of moderate GDP expansion as global economies recover. The BOJ anticipates that a virtuous cycle of rising wages and prices will continue. 

Government economic measures and accommodative financial conditions are expected to support this trend.

Board member Hajime Takata dissented by proposing a rate increase to 1%. He argued that price risks in Japan were tilted to the upside. 

December inflation data showed headline price growth at 2.1%, the lowest since March 2022. However, prices have remained above the 2% target for 45 consecutive months. 

Core-core inflation, which excludes fresh food and energy, registered 2.9% in December. The central bank projects underlying inflation will continue rising moderately.

Wage growth and sticky service prices above 2% continue to underpin inflation. Masahiko Loo from State Street Investment Management observed that the firm’s underlying inflation supports the BOJ’s normalization path. 

“This firm underlying inflation reinforces our view that the BOJ’s normalization path will stay intact, albeit at a gradual pace,” Loo stated. 

The bank expects inflation to fall below 2% in the first half of the year. Nevertheless, underlying price pressures remain supported by wage increases. Japan began policy normalization in March 2024 by ending negative interest rates.

Political pressure has intensified on the central bank’s tightening approach. Takaichi and other prominent figures advocate softer rates to boost economic growth. Japan’s third-quarter GDP contracted 0.6% quarter-on-quarter and 2.3% annualized. 

This exceeded initial estimates and highlights economic fragility. The government has planned a record $783 billion budget for the next fiscal year. A $135 billion stimulus package was also implemented last year to help households manage living costs.

Bond Yields Surge as Yen Weakens Against Dollar

Japanese bond yields have climbed to multidecade highs over the past month despite monetary tightening. 

Real rates remain negative while fiscal concerns mount. Ueda acknowledged long-term interest rates were rising at a fast pace. 

The BOJ governor assured markets that the central bank was ready to take nimble action to address exceptional moves. 

Ueda also emphasized that the bank will continue raising interest rates if economic and price forecasts materialize. Capital outflows have accelerated as yields rise.

The yen has declined significantly against the dollar since late last year. It fell approximately 4.6% from October 21, when Takaichi became prime minister. 

The currency currently trades around 158.97 per dollar. Finance Minister Satsuki Katayama warned against one-sided currency movements. 

She conveyed deep concern about yen depreciation to Treasury Secretary Scott Bessent in Washington last week.

Katayama reported Friday that the bond market rout appeared to have receded. She emphasized close monitoring of financial markets with high urgency. 

When asked about currency volatility, Ueda noted that instability remains elevated and requires scrutiny. “Volatility remains high,” Ueda stated, adding he would scrutinize developments. 

State Street projects one rate hike in 2026 and another in 2027. The terminal rate is expected to reach 1.25% under this base case scenario.

If the yen breaches 160 against the dollar, two hikes could occur this year. One increase might come as early as April, pushing the terminal rate to 1.5%. 

The terminal rate represents a level balancing inflation and economic growth. Market participants continue watching for signals on the timing of the next rate adjustment.