TOKYO — The Bank of Japan appears increasingly likely to raise interest rates again next week, pushing borrowing costs to their highest level in more than three decades. But for markets, the expected hike itself may no longer be the biggest question.
The real uncertainty is what comes afterward.
Economists and investors broadly expect the BOJ to lift its benchmark policy rate by 25 basis points, from 1% to 1.25%, when its two-day policy meeting concludes on September 18. The BOJ’s official calendar confirms policymakers will meet on September 17 and 18.
Japan Times coverage this week cited swap-market pricing showing roughly a 97% probability of another increase, underscoring how firmly investors have come to expect action. BOJ board member Kazuyuki Masu has also said the central bank should continue raising rates as underlying inflation approaches its 2% objective and while monetary conditions remain relatively accommodative.
If the BOJ delivers the widely anticipated quarter-point increase, the policy rate would climb to 1.25%, a level not seen in 31 years. It would also mark the second increase in just three months following June’s move to 1%, suggesting that Japan’s long era of exceptionally cheap money is ending faster than many investors previously expected.
Inflation is making it harder for the BOJ to wait
The case for higher rates received another boost from Japan’s latest wholesale inflation data.
The producer price index, which measures prices companies charge one another for goods and services, rose 7.6% in August from a year earlier, slightly faster than economists had forecast. At the same time, yen-based import prices surged 24.8% year on year, reflecting the combined effect of elevated global commodity costs and the currency’s earlier weakness.
That matters because Japan imports much of the energy and food it consumes. When the yen weakens, the cost of those imports rises, putting pressure on companies either to absorb the increase or pass it on to households.
Governor Kazuo Ueda has been watching precisely that transmission mechanism: whether businesses increasingly pass higher wholesale and import costs through to consumers. Persistent cost increases would strengthen the argument that inflation is becoming entrenched rather than temporary.
And the BOJ is no longer only worried about inflation falling short of its target.
Ueda said earlier this month that policymakers increasingly need to pay attention to upside risks to prices as underlying inflation moves closer to 2%, comments that were widely interpreted as opening the door to a September rate increase.
Japan’s economy is giving the BOJ more room to move
Higher rates are easier to justify when the economy is holding up.
Revised government data showed Japan’s economy expanded at an annualized 1.4% pace in the second quarter, stronger than the initial estimate of 1.1%. Although domestic consumption remained subdued, business investment performed slightly better than first estimated.
The wage picture has also strengthened.
Inflation-adjusted real wages increased 2.4% in July from a year earlier, their strongest rise since May 2021 and the seventh consecutive month of growth, while separate Japan Times reporting showed nominal wages climbed 4.7%.
That wage growth is critical to the BOJ.
For years, policymakers argued that Japan could only sustain inflation near 2% if higher prices were accompanied by stronger wages and household purchasing power. With both wages and underlying inflation rising, the central bank now has more justification for withdrawing monetary stimulus.
The yen has changed the equation
There is another powerful force pushing policymakers toward tighter monetary policy: the yen.
The Japanese currency plunged to a four-decade low earlier this year, prompting unusual coordinated intervention by Japan and the United States. Since then, expectations for BOJ rate increases have helped the yen recover sharply. Reuters reported that investors have become increasingly focused on whether higher Japanese rates will make yen-denominated assets more attractive and reduce incentives for traders to borrow cheaply in yen.
That could have implications far beyond Tokyo.
For decades, ultra-low Japanese interest rates helped fuel the global yen carry trade, in which investors borrowed cheaply in Japan and invested the money in higher-yielding assets abroad.
As Japanese rates rise and the yen strengthens, some of those trades become less profitable.
A large-scale unwinding could therefore create volatility in currencies, bonds and equities around the world — one reason global investors are paying unusually close attention to what was once considered one of the most predictable central banks.
A 1.25% rate may already be priced in — the next move isn’t
This is where the BOJ meeting could become more important than the headline rate decision.
Financial markets overwhelmingly expect 1.25%.
What they do not know is how far the BOJ ultimately intends to go.
Reuters reported that policymakers are unlikely to provide a clear estimate of a final, or “terminal,” rate because the BOJ wants future decisions to remain dependent on inflation, wages, economic growth and financial conditions.
That uncertainty leaves investors trying to determine whether 1.25% represents the later stages of Japan’s tightening cycle — or merely another stop on the way considerably higher.
A Reuters survey of economists found expectations that the BOJ could reach 1.75% by the second quarter of 2027, sooner than previously anticipated. Markets are already treating meetings later this year and in January as potential opportunities for additional tightening.
BOJ board member Masu added to those expectations by saying monetary tightening should continue as necessary to prevent underlying inflation from moving materially above 2%.
The BOJ is walking into a difficult balancing act
Going too slowly carries obvious risks.
Persistent inflation combined with another yen slide could push import costs higher, forcing households to pay more for food, energy and everyday goods.
But moving too aggressively creates a different set of problems.
Higher rates increase mortgage and corporate borrowing costs, push up government debt-servicing expenses and can place pressure on heavily indebted businesses and investors accustomed to decades of unusually cheap Japanese money.
Japan’s enormous government debt load also makes rising yields especially important for public finances.
That leaves Ueda attempting something few modern Japanese central bankers have had to do: normalise interest rates without destabilising an economy and financial system built around extremely low borrowing costs.
Why the September meeting could matter far beyond Japan
For households, another rate hike could eventually mean better returns on savings — but more expensive variable-rate mortgages and loans.
For businesses, financing becomes gradually more costly.
For currency markets, higher Japanese yields could provide further support for the yen.
And for international investors, the bigger risk is that Japan’s normalization begins pulling capital back home after decades in which Japanese money flowed into foreign government bonds, stocks and other assets.
The September decision therefore may contain little surprise.
The surprise could come from whatever Governor Ueda says afterward.
A move to 1.25% is increasingly being treated as almost inevitable.
Whether Japan stops near there, reaches 1.5% early next year, or continues toward the 1.75% level economists increasingly expect in 2027 could reshape everything from the yen and Japanese mortgages to global bond markets and the massive carry trades built during the age of near-zero Japanese rates.
And that makes the BOJ’s next rate hike potentially less important than the question markets still cannot answer:
How high is Japan finally prepared to let interest rates go?
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