The Bank of Japan is set to raise interest rates on Friday to the highest level in 31 years, in a new move away from decades of ultra-loose monetary policy, amid rising inflation risks resulting from rising oil prices and a weak yen, while markets cautiously await Governor Kazuo Ueda’s signals on the next path of tightening.
The bank is expected to raise the interest rate by 25 basis points to 1.25 percent from one percent, at the end of its meeting, which will continue on September 17 and 18. It will be the first increase in three months, after the bank kept the interest rate unchanged in July.
The expected move comes at a time when major central banks are moving to tighten policy to confront price pressures, with rising energy costs. For Japan, raising interest also represents an additional step towards ending a long era of very low borrowing costs, which made the yen one of the most prominent cheap financing currencies in the world.
The markets are waiting for Ueda
With investors pricing in the rate hike almost entirely, attention has shifted from Friday's decision itself to Oeda's press conference and whether it will provide clues on the timing and speed of the next hikes.
Katsutoshi Inadomi, chief strategist at Sumitomo Mitsui Trust Asset Management, said markets were divided on the impact of the messages the bank might send. Some believe that a more stringent tone may lower bond yields by dispelling fears of the Bank of Japan's delay in combating inflation, while others believe that it may raise yields by increasing expectations of the final level of interest rates.
He added that the uncertainty about the market's reaction may make the bank's best option avoid giving very clear signals about its next steps.
Analysts indicate the possibility that Board Member Toichiro Asada will oppose raising interest rates again, after he objected to the June increase. On the other hand, estimates within the bank suggest that a quarter-point increase should be sufficient instead of a larger step, to allow time to evaluate the impact of previous increases on the economy and financial markets.
Inflation changes the calculations
In 2024, the Bank of Japan ended its nearly decade-long monetary stimulus program, and has since begun gradually raising interest rates. But it now faces a different environment with rising fuel prices, a weaker yen making imports more expensive, and strong demand linked to investments in artificial intelligence.
Ueda had said earlier in September that core inflation had become “very close” to the bank’s target of 2 percent, stressing the need to pay greater attention to the risks of rising prices.
Economists polled by Reuters expect the interest rate to reach 1.25 percent this month, then to 1.5 percent by the end of next March, before rising to 1.75 percent during the second quarter of 2027. Most of them believe that the tightening cycle will not end before the interest rate reaches at least 1.75 percent.
Yen and bonds equation
But the biggest challenge for Ueda will be how to formulate his message. Insisting on a cautious, data-driven approach, without giving signals of further increases, may restore selling pressure on the yen, leading to an increase in the cost of imports and fueling inflation.
On the other hand, adopting a very hawkish tone could add new pressures to the government bond market, which has already witnessed a selling wave that pushed yields to their highest levels in three decades amid concerns about public finances.
Also, raising the interest rate to 1.25 percent will bring it within the range estimated by the Bank of Japan for the neutral nominal interest rate, between 1.1 and 2.5 percent, which is the level that neither stimulates nor suppresses the economy, which opens the door to questions about the distance remaining before the tightening cycle.
Although Ueda confirms that there is no predetermined level for the end of the interest rate hike cycle, sources familiar with the bank’s directions indicate that a number of officials still see room for additional increases. Board member Naoki Tamura, known for his hawkishness, estimates the neutral interest level at around 2 percent.
Fiscal policy increases complexity
The expansionary fiscal policy of Prime Minister Sanae Takaichi's government adds another dimension to the bank's calculations, especially with mounting concerns about debt and government spending.
The Director-General of the International Monetary Fund, Kristalina Georgieva, has warned that high debt levels and large financial support packages may increase the risks of rising inflation expectations, which forces central banks to move more forcefully to maintain price stability and the credibility of monetary policy.
Thus, Friday's rate hike appears less complicated than the message that will accompany it. The Bank of Japan needs to demonstrate its willingness to confront inflation without causing markets to price in a tightening cycle faster than it wants, or sparking a new wave of volatility in the yen and bonds.
Turkish Minister of Treasury and Finance Mehmet Simsek said that the inflation target for 2027 contained in the medium-term economic program is realistic from the markets’ point of view, provided that the war in Iran does not continue during the next year, at a time when the government expects inflation to decline to 21 percent in 2027, after reaching 28.4 percent this year.
Simsek added, in an interview with the Habertürk channel on Wednesday, that Türkiye should, under normal circumstances, operate according to a floating exchange rate system, because it provides the basis for responding correctly to economic shocks.
The Turkish government expects inflation to decline to single digits in 2029, about two years later than its previous target.
Simsek said that the government has always guaranteed public sector workers and retirees wage increases that are not less than the inflation rate, stressing that it will continue to follow this policy.
Exchange rate
The minister explained that Türkiye may abolish the obligation for exporters to sell part of their export proceeds once inflation drops to single digits, in preparation for the transition to a freer system.
He added that the conditions necessary to cancel this obligation have not yet been achieved, and that the government will reconsider the matter when the appropriate conditions are available.
Banking sector
Regarding the banking sector, Simsek said that Golden Globe Yaterim Bank, which is subject to US sanctions, is a small institution and does not pose a systemic risk to the Turkish financial sector. He called on other banks to adhere to international regulations and strengthen compliance procedures.
Simsek's statements come at a time when Turkey faces additional risks to the path of inflation as a result of rising energy prices and the repercussions of the war in the Middle East, which increases the importance of developments in oil prices and the exchange rate in relation to the path of local prices.
