BOJ to hike rates to 1.25 percent next week

The Bank of Japan is poised to raise its policy rate to 1.25 percent next week. This 25 basis point increase would set a new record high for the rate, unmatched for 31 years. The move comes just three months after the June hike, indicating an accelerated tightening cycle. Four sources familiar with internal deliberations confirm the likely trajectory. The central bank aims to curb inflation risks as underlying prices approach the 2 percent target.

Officials view the economic recovery as moderate but sufficient to support further rate increases. They believe financial conditions will remain loose even after the hike. A recent rebound in the yen may ease import costs, but fuel price surges keep officials cautious. The bank remains vigilant against an inflation overshoot driven by external factors.

Inflation pressures drive the decision

Annual wholesale inflation reached 7.6 percent in August. This figure signals mounting pressure on business costs. The BOJ predicts this will push consumer inflation above the 2 percent target in coming months. Core consumer inflation is projected to hit 2.5 percent in the fiscal year ending March 2027. Board members emphasize the need to monitor upside risks closely.

The bank previously warned of overshoot risks due to the Middle East conflict and weak yen. AI-related demand also contributes to price pressures. With underlying inflation near the target, the BOJ prioritizes preventing a sharp spike. This approach aligns with the recent shift toward a more hawkish stance.

Market expectations and board dynamics

Analysts polled by Reuters expect the rate to reach 1.5 percent by March next year. Most predict a terminal rate of at least 1.75 percent in 2027. Some market participants had speculated on a larger 50 basis point hike. However, sources indicate the board favors the standard 25 point increment.

There is no consensus on the pace of future hikes. Hawks argue inflation has already hit 2 percent. Doves, including dissenters from June, favor a slower approach. Governor Kazuo Ueda is expected to avoid committing to a specific timeline. He may signal a faster pace if financial conditions remain too loose.

No preset terminal rate exists

The BOJ has no fixed target for the final interest rate. The decision depends on how previous hikes affect the economy. It also relies on how firms pass input costs to households. The board will assess data after each meeting before deciding on further moves. Meetings are scheduled for October, December, and January.