Bank of Japan Poised to Lift Rates to 31-Year High as Fed Pressure Mounts

The Bank of Japan is expected to raise its policy rate to 1.25% from 1% at the conclusion of its two-day meeting on Friday, a move that would take borrowing costs to their highest level since 1995. The widely anticipated increase would be the first in three months and would edge the policy rate closer to the range the central bank considers neutral for the economy.

The decision comes just days after the Federal Reserve raised rates and signalled the possibility of another increase later this year. A widening rate gap between the United States and Japan could further weaken the yen, pushing up import costs and adding to inflation pressures. Analysts say this dynamic has raised the stakes for Governor Kazuo Ueda's post-meeting briefing, which markets will scrutinise for signals on the timing and pace of future increases.

"The BOJ will be under huge pressure after the Fed hiked rates and kept market expectations alive for more," said Takeshi Ishida, strategist at Kansai Mirai Bank. "The hurdle for Ueda's news conference has heightened."

Board member Toichiro Asada, who voted against the June hike, may dissent again, according to analysts. A move to 1.25% would bring the policy rate within the BOJ's estimated 1.1% to 2.5% range for Japan's nominal neutral rate, a level that neither stimulates nor restrains growth, raising questions about how much further the bank can tighten.

The BOJ ended its decade-long stimulus programme in 2024 and has raised rates roughly twice a year since, citing progress toward sustainably achieving its 2% inflation target. Even after Friday's expected hike, Japan's policy rate would remain below those of the European Central Bank, which raised its key rate to 2.5% last week, and the Fed's 3.75%-4.00% range.

Markets have almost fully priced in a September increase following a series of hawkish signals from the BOJ, including a July warning about the risk of an inflation overshoot driven by soaring fuel costs, a weak yen and strong demand linked to artificial intelligence. U.S. Treasury Secretary Scott Bessent said he expressed strong support for "decisive" monetary action to address yen weakness during a meeting with Ueda on the sidelines of a G20 finance leaders' gathering this month.

Despite the expected move, Ueda and other BOJ officials have remained vague about the speed and extent of future rate hikes, saying much depends on the inflation outlook and how past increases affect financial conditions. Analysts polled expect the BOJ to raise rates to 1.5% by the end of March next year and to 1.75% in the second quarter of 2027, with most seeing a terminal rate of at least 1.75%.