A guide sign reading “Bank of Japan” is seen in Tokyo on July 31, 2024.
Kazuhiro Nogi | Afp | Getty Images
Japan’s central bank on Friday raised economic growth forecasts while holding its key policy rate at 0.75% as the country prepares to go into an election.
The Bank of Japan upgraded its economic growth forecast for the fiscal year ending in March 2026 to 0.9% from 0.7% in October 2025, and also raised its GDP expansion outlook for the 2026 fiscal year to 1% from 0.7%.
The central bank expects Japan’s GDP to grow moderately as other countries return to growth, and the BOJ sees a virtuous cycle of rising prices and wages, supported by government’s economic measures and accommodative financial conditions.
The central bank kept the benchmark interest rate steady in a split 8-1 decision, after raising it to the highest level in 30 years in December, ahead of snap polls that could see Prime Minister Sanae Takaichi sharpen her advocacy for monetary easing and fiscal support.
In its statement, the BOJ revealed that board member Hajime Takata had proposed raising rates to 1%, saying that risks to prices in Japan were skewed to the upside.
The bank, which forecast inflation to fall below the 2% target in the first half of the year, expects underlying inflation to “continue rising moderately.”
Underlying inflation is still supported by wage growth and sticky prices of services that continue to run above 2%, according to Masahiko Loo, senior fixed income strategist at State Street Investment Management.
“This firm underlying inflation reinforces our view that the BOJ’s normalization path will stay intact, albeit at a gradual pace,” he said.
Japan’s December inflation data, released earlier in the day, showed headline price growth coming in at 2.1%, its lowest since March 2022, but still running above the BOJ’s target of 2% for a 45th straight month.
So called “core-core” inflation, which strips out fresh food and energy prices, came in at 2.9% in December.
Japan embarked on the path to policy normalization in March 2024, abandoning the world’s last negative interest rate regime, and has stressed on raising rates subject to a virtuous cycle of growth in wages and prices.
That policy, however, has come under political pressure with prominent names including Takaichi advocating for softer rates to fuel economic growth. Japan’s economy shrank more than initially estimated in the third quarter, contracting 0.6% quarter on quarter, and 2.3% on an annualized basis.
BOJ Governor Kazuo Ueda said Friday that the bank will continue to raise interest rates if its economic and price forecasts materialize, according to a Reuters translation of his remarks.
Bond and yen worries
Despite BOJ’s monetary tightening, Japanese bond yields have been rising, hitting multidecade highs over the past month, driving capital outflows and weakening the yen. This comes as real rates still remain negative, according to the BOJ, as well as mounting fiscal worries.
Ueda said the rise of long-term interest rates were going at a “fast pace,” but that the BOJ was ready to take “nimble action to cope with exceptional moves.”
Takaichi had planned a record $783 billion budget for the next fiscal year, starting April 1, on top of a $135 billion stimulus package last year targeted at helping households with the rising cost of living.
Pressured by rising yields amid fiscal concerns, the yen has seen a significant decline against the dollar toward the end of last year, falling about 4.6% since Oct. 21, when Takaichi became prime minister to its current level of 158.97.
This weakness prompted Finance Minister Satsuki Katayama to warn against “one-sided” moves in the currency. Katayama reportedly told reporters in Washington last week that she has conveyed her “deep concern” over the depreciation in yen and Treasury Secretary Scott Bessent shared her view on “one-sided” weakness in the Japanese currency.
On Friday, she reportedly said that the bond market rout has appeared to have receded, and that she was closely monitoring financial markets with a “high sense of urgency.”
When asked if he agreed with Katayama, Ueda said that “volatility remains high” and that he would “scrutinise developments carefully.”
State Street’s Loo said that his base case for the BOJ is one hike in 2026 and another in 2027 with a terminal rate of 1.25%. If the yen breaches the 160 level against the dollar, there could be two hikes this year and one as early as April, bringing the terminal rate to 1.5%.
A terminal rate, also known as the neutral rate, is one that one that balances inflation and economic growth.
Separately, Takaichi on Friday dissolved Japan’s Lower House, with the country set to go to polls in a snap election on Feb. 8.
