BoJ Holds at 0.75% as Markets Eye Debt, Elections

BoJ pauses after sharp December rate hike

The Bank of Japan kept its uncollateralised overnight call rate at around 0.75% on Friday, matching market expectations following a period of bond market turbulence. The policy board, led by Governor Kazuo Ueda, voted 8–1 to maintain the rate, which was raised by 25 basis points in December to its highest level since 1995. That December move had lifted the key interest rate to 0.75%, ending a long era of near‑zero or negative rates as the central bank continued its policy normalisation.

In its latest Outlook for Economic Activity and Prices, the BoJ said Japan’s economy is likely to continue growing moderately as overseas economies return to a growth path and a virtuous cycle from income to spending gradually strengthens. The central bank noted that inflation is expected to decelerate below 2% in the first half of this year as earlier food price increases fade, before stabilising close to its target in later years.

Holding rates steady allows the economy time to digest the December increase, which had already marked a significant shift after decades of ultra‑loose policy. However, the decision does not directly resolve the financial market stress seen this week, particularly in long‑dated government bonds, or broader investor worries over Japan’s fiscal position.

Growth outlook revised up despite medium‑term caution

Alongside its rate decision, the BoJ upgraded near‑term growth projections. Real GDP growth for fiscal 2025 was raised to 0.9% from 0.7%, and the forecast for the current fiscal year was lifted to 1.0%, also from 0.7%. The bank cited the impact of government economic measures in supporting activity. At the same time, it revised down its projection for fiscal 2027 growth to 0.8% from 1.0%, signalling expectations of a slower expansion later in the forecast horizon.

On prices, the BoJ left its fiscal 2025 inflation forecast at 2.7% and nudged its fiscal 2026 projection slightly higher to 1.9% from 1.8%, while keeping the fiscal 2027 outlook at 2.0%. The bank said it expects inflation to temporarily fall below 2% in the near term before moving closer to target, reinforcing the case for a gradual, data‑dependent approach to further policy adjustments.

The combination of a stronger near‑term growth outlook and a still‑cautious medium‑term view underscores the central bank’s balancing act: supporting the recovery and anchoring inflation expectations, while avoiding an abrupt tightening that could unsettle financial conditions or weaken domestic demand.

Bond market rout exposes fiscal and political fault lines

This week’s decision followed what was described as a historic sell‑off in Japanese government bonds. On Tuesday, the yield on the 40‑year JGB climbed above 4% for the first time since 2007, while the 30‑year yield surged almost 30 basis points during the session to around 3.9%, its highest level on record. The sharp moves reflected heightened concern over Japan’s fiscal outlook and political developments rather than a change in central bank policy alone.

Markets reacted to Prime Minister Sanae Takaichi’s announcement on Monday of snap elections scheduled for 8 February and a proposal to suspend the 8% consumption tax on food for two years. Annual revenue from that tax is about ¥5 trillion (€31.5 billion). With Japan’s debt‑to‑GDP ratio hovering near 240%, the highest among developed economies, investors questioned the sustainability of unfunded tax cuts combined with additional spending.

Takaichi also unveiled a spending package of roughly ¥21.5 trillion (€115 billion), which intensified debate over fiscal discipline. The mix of planned tax relief and higher expenditure drew comparisons from some observers to the UK’s 2022 “mini‑budget,” which triggered market turmoil. While those comparisons are external characterisations, the immediate market response in Japan has been visible through rising long‑term yields and increased scrutiny of government borrowing needs.

Political backdrop adds to policy uncertainty

The fiscal announcements come against a backdrop of political flux. Sanae Takaichi became Japan’s first female prime minister in October 2025 after Shigeru Ishiba resigned following a series of political setbacks. Under her leadership, the ruling Liberal Democratic Party (LDP) has governed in coalition with the Japan Innovation Party (JIP) after its long‑standing alliance with centrist Komeito collapsed amid a political funds scandal.

Although the LDP‑JIP coalition holds only a slim majority, it has so far maintained relatively high approval ratings, particularly among younger voters. The decision to call early elections and pursue tax cuts and new spending appears aimed at consolidating political support. For investors and the BoJ, however, these steps add another layer of uncertainty around the medium‑term fiscal trajectory, which will continue to interact with monetary policy and financial market conditions.