Bank of Japan raises interest rates, announces bond tapering plan

BOJ interest rates: The Bank of Japan (BOJ) raised interest rates on Wednesday and outlined a new plan for quantitative tightening, marking a significant shift from a decade of aggressive monetary stimulus.

In a decision that surprised many market observers, the BOJ increased its short-term policy rate to 0.25% from a previous range of 0-0.1 per cent, in a 7-2 vote. This is the highest rate level since 2008.

The central bank also introduced a quantitative tightening (QT) plan that will halve its monthly bond purchases to 3 trillion yen ($19.6 billion) starting from January-March 2026, down from the current 6 trillion yen.

"Despite sluggish consumer spending, the BOJ has taken a decisive step by raising rates and initiating a more gradual reduction of its balance sheet," said Fred Neumann, chief Asia economist at HSBC. "Rising inflation expectations suggest that the BOJ is likely to continue normalizing its monetary policy, with another rate hike possible by early next year."

Following the announcement, the yen initially surged by 0.8 per cent to a three-month high of 151.58 per dollar but later retraced some of those gains. Yields on 10-year Japanese government bonds also saw a slight decline.

The BOJ stated that the rate increase reflects its view that wage hikes are broadening and leading firms to pass on higher labor costs through service price increases. It noted that import prices are accelerating despite some recent moderation, emphasising the need to remain vigilant against potential inflation overshoots.

In its quarterly outlook report, the BOJ maintained its April forecast, projecting that inflation will remain around 2 per cent through fiscal 2026. BOJ Governor Kazuo Ueda is expected to hold a news conference at 3:30 p.m. (0630 GMT) to further explain the decision.

This move by the BOJ comes as the U.S. Federal Reserve considers rate cuts, potentially starting in September, following a period of aggressive rate hikes that had contributed to a stronger dollar and a weaker yen.

More than three-quarters of economists polled by Reuters earlier this month had anticipated that the BOJ would keep rates unchanged in July. The BOJ had ended its negative interest rate policy and bond yield control in March, marking a significant shift from its previous stimulus strategies.

Ueda has indicated that further rate hikes may be considered if rising wages support sustained inflation around the 2 per cent target. The BOJ aims to eventually adjust short-term rates to levels that neither stimulate nor cool growth, projected to be between 0.5 per cent and 1.5 per cent in the coming years if inflation targets are met.