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The Bank of Japan (BOJ) is expected to raise its policy interest rate next week, most likely by 25 basis points, as persistent price pressures increase the risk of inflation exceeding the central bank’s target, according to four sources familiar with its thinking.
A 25-basis-point increase would take the policy rate to 1.25%, its highest level in 31 years. Raising rates just three months after the BOJ’s previous increase in June would also point to a faster pace of monetary tightening, particularly if another hike follows before the end of the year.
The sources said conditions are increasingly aligning for another rate increase, with the Japanese economy expected to continue its moderate recovery while underlying price pressures remain elevated.
Even if the BOJ raises its policy rate to 1.25%, financial conditions are expected to remain relatively accommodative, the sources said. They spoke anonymously because they were not authorised to discuss the central bank’s deliberations publicly.
The recent recovery in the yen could reduce some price pressure by lowering import costs. However, the effects of previous yen weakness and a renewed increase in fuel prices are expected to keep inflation risks firmly on the BOJ’s agenda.
“With underlying inflation so close to 2%, the BOJ needs to be extra mindful of upside price risks,” one of the sources said, a view shared by the other sources.
BOJ weighs gradual tightening
The BOJ raised its policy rate to 1% in June and indicated that it would continue increasing borrowing costs if economic and price developments remained consistent with its baseline outlook.
The central bank left rates unchanged in July but signalled that another increase could come relatively soon. It highlighted the risk of an inflation overshoot resulting from price pressures linked to the Middle East conflict, a weaker yen, and strong demand associated with artificial intelligence.
Analysts expect the BOJ to raise rates to 1.25% at its September 17–18 meeting, followed by an increase to 1.5% by the end of March next year and 1.75% in the second quarter of 2027. Most analysts expect the eventual terminal rate to reach at least 1.75%.
With financial markets already fully pricing in a September increase, some investors had speculated that the BOJ could surprise markets with a larger 50-basis-point hike.
However, the sources said the absence of an immediate acceleration in wage and price growth makes a conventional 25-basis-point increase more likely. The BOJ is expected to use subsequent economic data to determine whether another increase will be required in the near term.
BOJ board member Kazuyuki Masu said on Thursday that underlying inflation was approaching 2%, but there was no evidence of a sharp overshoot. His comments suggested that he saw little immediate justification for a significantly larger increase at next week’s meeting.
BOJ has no fixed terminal rate
Markets are also watching for signals from Governor Kazuo Ueda’s post-meeting briefing about the pace of future rate increases and how high borrowing costs could rise during the current tightening cycle.
The sources said the BOJ does not appear to have a predetermined terminal rate. Instead, the eventual level will depend on the impact of previous rate increases on economic activity and the extent to which companies pass higher input costs on to consumers.
There is also disagreement within the central bank over how quickly rates should rise. Some policymakers believe underlying inflation has already reached 2%, while others, including Toichiro Asada, who opposed the June rate increase, favour a more cautious approach.
Ueda is therefore expected to avoid committing to a specific timetable for future hikes. However, he could reiterate his July position that the BOJ may accelerate rate increases if financial conditions become excessively loose.
After the September meeting, the BOJ is scheduled to hold policy meetings in October and December, followed by another meeting in January next year.
Wholesale inflation adds pressure
Japan’s annual wholesale inflation rate reached 7.6% in August, highlighting the continued build-up in price pressures and strengthening expectations that consumer inflation could move above the BOJ’s 2% target in the coming months.
In its quarterly projections released in July, the central bank forecast core consumer inflation at 2.5% for the fiscal year ending March 2027 and 2.4% for the following fiscal year, before returning to 2% in the subsequent year.
The yen has gained more than 6% since Japan and the United States intervened jointly in late July, which should help moderate import costs. However, that benefit is being offset by a surge in Brent crude prices above $100 a barrel, raising concerns about renewed inflationary pressure.
The combination of elevated wholesale prices, higher energy costs, and inflation approaching the BOJ’s target will leave policymakers balancing the need to normalise monetary policy against the risk of tightening too aggressively.
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