11 February 2025
Erica Camilleri, CFA, Senior Global Macro Analyst, Multi-Asset Solutions Team
The Bank of Japan (BoJ) has continued to raise interest rates in an effort to "normalise" monetary policy, presenting potential opportunities for discerning investors.
On 24 January, 2025, the Bank of Japan raised its key policy interest rate by 25 basis points to 0.50%—the highest it’s been in 17 years, signaling the central bank’s mounting confidence that rising wages should keep Japanese inflation at or around its 2% target. This latest step marks the BoJ’s third rate hike in a monetary policy normalisation cycle that began nearly a year ago, leaving many policy watchers and investors now wondering: Just how high might the BoJ take rates?
The January rate hike is unlikely to be the BoJ’s last move higher, in our view. Indeed, ongoing policy normalisation in Japan remains one of our team’s strongest-conviction macroeconomic themes, as the central bank attempts to bring its benchmark rate up to a neutral threshold after years of ultra-accommodative monetary policy. Our current base case calls for one more BoJ rate hike in 2025 and another two in 2026, which would imply a terminal rate of at least 1.25%. Market pricing finally reflects our 2025 rate outlook for Japan, with an additional hike now priced into the latter half of the year.
The anticipation of several further rate increases over the next two years makes the BoJ an outlier among the world’s developed-market central banks, most of which appear to be in some stage of policy easing at this juncture. (See Five macroeconomic themes for 2025: a global economy in transition to learn more.) The BoJ similarly bucked the prevailing trend in 2022 when it opted not to raise interest rates, even as other major central banks were doing so in an effort to rein in stubborn inflation.
The main reason we believe the BoJ can and will continue to gradually raise rates in the period ahead is simply that domestic economic conditions have improved recently, enabling Japan to finally break out of its multidecade deflationary spiral:
Japan’s 2025 spring wage negotiations may support continued wage growth
Sources: RENGO, SBJ, Macrobond, Manulife Investment Management, as of 22/1/25. The Consumer Price Index (CPI) tracks the average change of prices over time by urban consumers for a market basket of goods and services. It is not possible to invest directly in an index.
Along with Japan’s favorable domestic macro backdrop, other factors might also bolster the BoJ’s more hawkish policy stance going forward.
For one thing, further rate hikes would likely support the still-weak Japanese currency (the yen), which today sits near 30-year lows and is helping to push consumer prices up via more expensive imports from abroad. Also, the BoJ conducted an empirical study showing that Japan’s extended era of rock-bottom rates didn’t produce all of the desired results, underscoring the BoJ’s present need to normalise monetary policy. While there were modest positive impacts on Japan’s economy, there were also negative impacts on the Japanese bond market’s functioning and on many financial institutions’ interest margins.
From a more tactical perspective, the BoJ’s rate actions may be influenced to some degree by US monetary policy developments and global capital markets behavior. A deep rate-cutting cycle by the US Federal Reserve (Fed) may have created a headwind for BoJ rate hikes, but the Fed’s relatively less dovish position in recent months should make it easier for the BoJ to keep lifting its policy rate. The potential for market volatility in response to global trade uncertainty could also pose a risk to BoJ rate increases, given the central bank’s cautious and risk-averse tendencies. However, we perceive Japan as being less vulnerable to US tariffs than China, Europe, and Canada.
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