^{Photo: The Japan Times}

Policy Decision at a Glance

The Bank of Japan has raised its benchmark short term interest rate to the highest level in nearly 30 years, pressing ahead with its long awaited exit from ultra loose monetary policy. The central bank increased rates by 25 basis points to 0.75 percent, marking the most restrictive stance since 1995 and matching expectations from market economists.

The move triggered an immediate selloff in Japanese government bonds, pushing long term yields to levels not seen since the late 1990s and signaling a decisive shift in Japan’s financial landscape.

Bond Market Reaction and Asset Moves

Following the announcement, the yield on the benchmark 10 year Japanese government bond climbed roughly 5 basis points to around 2.02 percent, crossing the psychologically important 2 percent threshold for the first time since 1999. The 20 year JGB yield also rose, reaching nearly 3 percent, another multi decade high.

In currency markets, the yen weakened modestly, slipping about 0.25 percent to roughly 155.9 per dollar. Japanese equities moved in the opposite direction, with the Nikkei 225 gaining more than 1 percent as investors interpreted the move as confirmation of confidence in corporate earnings and wage growth.

Why the BOJ Is Moving Now

Japan’s central bank has been steadily normalizing policy since abandoning its negative interest rate regime last year, ending a period of extraordinary stimulus that had been in place since 2016. The BOJ has repeatedly stated that its objective is to establish a sustainable cycle in which rising wages support higher prices and stable economic growth.

Inflation has now exceeded the BOJ’s 2 percent target for 44 consecutive months. Data released earlier on Friday showed consumer prices rising 2.9 percent in November, reinforcing the case for tighter policy. However, real wages have continued to fall, declining for ten straight months, as price increases have outpaced income growth.

Despite the rate hike, the BOJ emphasized that real interest rates remain significantly negative, indicating that overall financial conditions are still accommodative and supportive of economic activity.

Economic Risks and Growth Concerns

The policy shift comes against a backdrop of economic weakness. Revised data showed Japan’s economy contracted more sharply than initially estimated in the third quarter, shrinking 0.6 percent quarter on quarter and 2.3 percent on an annualized basis.

Higher interest rates risk amplifying this slowdown by raising borrowing costs for households, businesses, and the government. The BOJ acknowledged these risks but argued that strong corporate profits and continued wage increases would help cushion the impact.

The central bank stated that companies are likely to keep raising wages in 2026 and pass higher labor costs on to selling prices, supporting what it described as a stable mechanism for moderate wage and price growth.

Inflation Outlook and Forward Guidance

While inflation has remained stubbornly above target, the BOJ expects some easing ahead. It projects that core inflation, which excludes fresh food prices, could fall below 2 percent between April and September 2026. This slowdown is expected to result from easing food price pressures and the effects of government measures aimed at reducing the cost of living.

BOJ officials noted that the probability of underlying inflation sustainably reaching the 2 percent target is increasing, a key justification for continuing the gradual removal of monetary stimulus.

Fiscal Pressure and Japan’s Debt Challenge

Rising bond yields also raise concerns about Japan’s public finances. The country carries the highest debt to GDP ratio among major economies, at close to 230 percent, according to International Monetary Fund data. Even modest increases in yields can significantly lift debt servicing costs over time.

At the same time, higher yields may offer some relief to the yen, which has traded in a weak range of roughly 154 to 157 per dollar since November. The currency has lost more than 2.5 percent since Prime Minister Sanae Takaichi took office in October, reflecting investor concerns over policy direction and inflation.

Political Context and Policy Tensions

The rate hike comes amid evolving political dynamics. Prime Minister Takaichi previously opposed tighter monetary policy during her leadership campaign, favoring continued stimulus. Since taking office, however, she has softened her stance as inflation and the weak yen have intensified pressure on household budgets.

In November, her government approved a large scale stimulus package worth 21.3 trillion yen, or about $135.5 billion, aimed at supporting consumers and reviving the slowing economy.

What Comes Next for Interest Rates

Economists expect further gradual tightening. Shigeto Nagai of Oxford Economics has indicated that the BOJ could raise rates again by mid 2026, potentially taking the policy rate to around 1 percent, which many see as a neutral level that neither stimulates nor restrains growth.

BOJ Governor Kazuo Ueda has cautioned that estimating the terminal rate remains difficult, with internal projections placing it somewhere between 1 percent and 2.5 percent. Future moves will depend heavily on wage trends, inflation momentum, and political tolerance for higher borrowing costs.

Bigger Picture

This latest rate hike marks a defining moment for Japan’s economy, ending an era of near zero rates and signaling renewed confidence in domestic inflation dynamics. While risks to growth and public finances remain, the BOJ’s actions suggest it believes Japan is finally emerging from decades of deflationary pressure and entering a more conventional monetary environment.