Bank of Japan Interest Rate Outlook

By Leika Kihara and Takahiko Wada

TOKYO (Reuters) – The Bank of Japan (BOJ) is likely to raise interest rates in the coming months, with January emerging as the most likely timing, according to former BOJ board member Makoto Sakurai, who spoke on Tuesday.

The central bank aims to raise short-term borrowing costs, currently at 0.25%, to between 1.5% and 2% by the end of Governor Kazuo Ueda's term in April 2028.

Sakurai stated, "The BOJ probably wants to hike rates once more by March next year. The exact timing will depend on market and political developments."

With ongoing domestic political flux, acting in December could be tricky. Sakurai indicated that January seems more likely since the BOJ would have more data, including information on consumption and wage growth.

However, the likelihood of a December rate hike increases if the yen declines towards its July low near 162 to the dollar, which it reached earlier this year. As of Tuesday, the dollar stood at 152.45 yen.

Sakurai noted, "Governor Ueda emphasized his resolve to keep raising rates at last week's news conference, which reflects the BOJ’s desire to avoid triggering excessive yen falls."

The dollar dipped below 152 yen on Thursday when the BOJ kept rates steady but implied near-term action by changing its language regarding scrutiny of U.S.-related risks.

The BOJ's next policy meetings are scheduled for December 18-19 and January 23-24. Having exited a decade-long stimulus program in March and raised its short-term policy target to 0.25% in July, the BOJ is focused on achieving a sustainable 2% inflation target.

While many analysts expect a rate hike by the end of the current fiscal year in March, opinions vary on whether the BOJ will act in December or wait until January or March.

Recent electoral shifts, with Japan's ruling coalition losing its majority on October 27, have amplified concerns about political instability, with Prime Minister Shigeru Ishiba needing to engage opposition parties to maintain power. This political uncertainty, coupled with potential market volatility post-U.S. elections, might lead the BOJ to postpone decisions until January.

Another critical consideration for the BOJ is whether wage growth will extend to smaller businesses and thus support consumer spending.

After a potential hike by March, the BOJ is likely to target one or two rate increases annually from 2025 to 2027, aiming to eventually reach a 1.5% to 2% target, according to Sakurai.

He warned, "There's too much uncertainty to predict the exact pace of further rate hikes. However, the BOJ is likely hoping for around 2% in the long run."

Japan’s anticipated significant debt issuance and calls for increased fiscal spending may also limit the BOJ's capacity to taper its bond purchases. In July, the BOJ announced plans to reduce its monthly JGB purchases to 3 trillion yen ($19.7 billion) starting in January-March 2026, potentially trimming its massive balance sheet by 8%.

A review of the BOJ's existing quantitative tightening (QT) program is set for June of next year, with a tapering plan to be discussed for implementation starting April 2026. Despite the intention to reduce bond purchases, Sakurai expressed doubts about the feasibility given the need to manage new debt and spending.

He stated, "The BOJ may be compelled to continue buying approximately 3 trillion yen worth of bonds well beyond fiscal 2026."

($1 = 152.3900 yen)