The Bank of Japan (BOJ) is expected to announce its final rate decision of the year around 11:00 on Friday (December 19), with markets anticipating a benchmark rate increase to the highest level in three decades as part of its policy normalization efforts initiated last year.
The potential hike could raise rates to 0.75%—the highest since 1995—with LSEG data showing an 86.4% probability of such action. This move may pressure the USD/JPY exchange rate and curb inflation, which has exceeded the BOJ's target for 44 consecutive months. However, it risks further slowing Japan's already fragile economy, which contracted in Q3.
Revised GDP figures revealed a deeper-than-initially-reported Q3 contraction of 0.6% quarter-on-quarter, or 2.3% annualized. With a rate hike nearly certain, analysts suggest market focus will shift to the BOJ's post-decision policy statement. Gregor MA Hirt, CIO of Global Multi-Asset at Allianz Global Investors, noted that market reactions will hinge on nuances in the BOJ's communication.
Key attention will center on signals regarding the neutral rate (the terminal rate balancing inflation and growth) and commentary on yen weakness. BOJ Governor Kazuo Ueda recently stated that estimating the terminal rate remains challenging, with the central bank's projected range between 1% and 2.5%. "The neutral rate is unfortunately a concept where we can only provide a very wide estimate," Ueda told parliament.
Carl Ang, Fixed Income Research Analyst at MFS Investment Management, suggested updated neutral rate projections might emerge after Friday's meeting.
Japan began policy normalization last year by exiting its globally unique negative rate framework maintained since 2016. The BOJ has since pursued gradual hikes, with investors now scrutinizing clues about future tightening pace. While markets broadly expect another hike by June 2026, ING predicts a possible delay until October 2026. Conversely, Bank of America forecasts a June 2024 hike, though it doesn't rule out an April move if yen depreciation accelerates, projecting a terminal rate of 1.5% by end-2027.
Ang emphasized that barring "major shocks," the BOJ won't deviate from its rate path despite risks like U.S. economic slowdown and diplomatic tensions.
In bond and FX markets, Allianz's Hirt observed that while the BOJ hasn't directly addressed currency concerns, explicit intervention signals from Ueda could establish policy "red lines." USD/JPY has mostly traded within 154-157 since November, with the yen depreciating over 2.5% since hawkish PM Sanae Takaichi—previously opposed to rate hikes—took office in October. On Friday, USD/JPY rose 0.19%.
The rate increase will also elevate Japanese government bond yields and borrowing costs, complicating the government's pandemic-era stimulus efforts. Should benchmark yields rise from ~2% to 2.5%, Japan's borrowing costs could double, with 10-year JGB yields currently near 1.970%—approaching an 18-year high of 1.983%.
At 2.5% yields, Japan's interest payments could surge to ¥16.1 trillion by FY2028 from ¥7.9 trillion in FY2024. Given fiscal concerns and potential FX intervention—which Finance Minister Mayumi Katayama hasn't ruled out—Ang expects USD/JPY to remain within 150-160 next year.
As of 09:29 Beijing time, USD/JPY traded at 155.79/80.
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