The Bank of Japan, which raised its benchmark interest rate by 0.25 percentage points to 0.75% on January 19, made clear its intention to maintain the rate hike trajectory into next year. The move marks a declaration to pursue full monetary policy normalization, breaking free from three decades of ultra-low interest rates and the resulting yen weakness.
BOJ Governor Kazuo Ueda said at a press conference following the monetary policy meeting, "We will continue to adjust the degree of monetary easing." However, he added that "the pace of rate increases will be determined by comprehensively considering factors such as real interest rates and lending trends at financial institutions," signaling a measured approach.
Bloomberg assessed that the remarks "will disappoint those who expected hawkish comments while providing relief to those who hoped for a cautious approach."
Japan's rate hike push comes primarily from the urgent need to combat high inflation. November's consumer price index, released the same day, rose 2.9% year-on-year, exceeding the BOJ's 2% target for the 44th consecutive month. Monetary authorities view the situation seriously, recognizing that the weak yen is pushing up import prices and fueling inflation. Governor Ueda emphasized that "many members at this meeting pointed out the negative impact of yen weakness on prices."
Fortunately, underlying conditions are supportive. First, the impact of U.S. tariffs is gradually subsiding, which is cited as a key factor enabling the BOJ to accelerate rate normalization. Japan's November exports rose 6.1% year-on-year, with exports to the United States (up 8.8%) turning positive for the first time in eight months. Nihon Keizai Shimbun forecast that "having confirmed the tariff shock is milder than expected, the BOJ will seek to exit its ultra-low rate policy more quickly." Additionally, the move aims to preemptively prevent substantial wage increases announced by major companies for next year from entrenching inflation.
Japan's exit from ultra-low rates is expected to bring changes to global financial markets. Japan's 10-year government bond yield, which had been rising on rate hike expectations, surged to 2.02% immediately after the BOJ's decision, reaching its highest level in 26 years since 1999. If Japanese government bonds, long considered a safe-haven asset alongside U.S. and German bonds, offer higher yields, bond investors may flock to them. When Japanese and Chinese long-term government bond yields inverted earlier this month, analysts called it "a signal of Asian bond market restructuring."
Japanese investors had turned to overseas markets including China due to domestic ultra-low rates. According to Bloomberg, Japanese investors' holdings of Chinese bonds increased 53% from a year earlier last year. Market observers expect portfolio adjustments, with investors buying Japanese government bonds instead of Chinese ones as domestic yields rise.
Experts are particularly concerned that the "yen carry trade," premised on a cheap yen, could face unwinding pressure from rate hikes and trigger increased market volatility. The risk of unwinding has grown as the recent U.S. rate-cutting trend narrows not only the interest rate differential between the two countries but also expectations for currency gains. In December 2023, the policy rate gap between the U.S. (5.5%) and Japan (-0.1%) was 5.6 percentage points, but Japan's latest hike has narrowed it to 3 percentage points. Yen carry trade funds, estimated at 506.6 trillion yen (approximately 4,803.7 trillion won, or $3.4 trillion), now face potential unwinding at any time. According to Bank of Korea estimates, 6.5% of this amount, or 32.7 trillion yen, is within the unwinding range due to rate hikes. If carry trade unwinding accelerates, markets could face shocks similar to "Black Monday" last August, when stock markets including Korea's plunged.
However, experts commonly view that Japan-originated market shocks will be limited, given the BOJ's signal of a measured pace while monitoring economic and market conditions. Governor Ueda, who had previously indicated a neutral rate of 1.0% to 2.5%, reassured markets by saying "it is difficult to specify the neutral rate in advance." Some analysts suggest the BOJ considered potential market shocks from conflicting with the Sanae Takaichi administration, which is pushing expansionary fiscal policy through a massive supplementary budget of 18.3 trillion yen (approximately 174 trillion won, or $122 billion). Government debt at 230% of GDP and real estate loans that have swollen to record levels this month are also potential flashpoints.
Kim Yu-mi, head of investment strategy at Kiwoom Securities, noted, "Japan is in a difficult position to raise rates aggressively." Nikkei forecast that the yen's appreciation effect may also be limited due to the measured pace of rate hikes. Despite the rate increase, the yen remained around 155 per dollar during trading, failing to shake off selling pressure. Lee Jin-kyung, a researcher at Shinhan Investment Corp., projected that "yen weakness will continue in the short term."
