BOJ seen pausing at 1.25% but eyeing December hike

The Bank of Japan is set to keep its key policy rate at 1.25% at the conclusion of a two-day meeting on Friday, opting to forgo a back-to-back hike in order to assess the impact of earlier increases on lending conditions. While holding the rate steady, policymakers are preparing to signal that a rate increase as soon as December remains on the table, framing the decision as a pause rather than an end to tightening.

In its quarterly outlook due after the meeting, the central bank is expected to slightly raise its inflation forecast for the next fiscal year and indicate that underlying, or core, inflation has roughly reached the 2% target. Officials also plan to stress that inflation could overshoot the 2% goal, setting a hawkish tone even as the headline policy rate remains unchanged for now.

With wage gains becoming more firmly established and inflation expectations hovering around 2%, the Bank of Japan is likely to emphasise a shift in focus from achieving the inflation target to anchoring price growth around that level. This would mean guiding interest rates toward levels viewed as neutral for the economy rather than relying on the ultra-loose framework that characterised past policy.

The policy pivot follows years of aggressive stimulus launched in 2013 under former governor Haruhiko Kuroda, which aimed to lift Japan out of deflation and achieve 2% inflation. Even after ending a range of unorthodox easing measures in 2024, the central bank had raised rates only cautiously, judging that underlying inflation driven by domestic demand was still below target. The latest signals suggest officials now see that condition as largely met.

The current 1.25% policy rate now lies within the Bank of Japan staff’s estimated neutral range of 1.1% to 2.5%, a band in which interest rates are considered neither restrictive nor stimulative for overall economic activity. Growth in bank lending remains strong, and financial conditions are described as loose, suggesting room for additional tightening before policy becomes restrictive.

Analysts surveyed expect the central bank to lift the policy rate to 1.5% in December and then continue with rate increases on roughly a quarterly schedule. Market attention is increasingly focused on how far rates might ultimately rise within or beyond the neutral range as inflation dynamics and wage trends evolve.

Officials are expected to avoid giving explicit guidance on the exact timing and pace of further increases, aiming instead to retain flexibility. The central bank is seen as trying to prevent an excessive acceleration in inflation while also avoiding market disruption that could come from signaling a premature or overly aggressive tightening path.

Decision makers plan to scrutinise upcoming economic data and financial market developments in deciding whether to move in December or wait until January. One bond strategist described the current phase as a historical moment for the Bank of Japan, as it transitions from a long period of pressing the monetary accelerator to a more complex task that also involves applying the brakes.

The Bank of Japan’s meeting comes in a week when the US Federal Reserve and the European Central Bank are both expected to leave their own benchmark rates unchanged at upcoming meetings. Nonetheless, hawkish messaging from Tokyo could reinforce expectations that all three central banks may raise rates by year-end.

Global inflation pressures remain elevated, driven in part by brisk demand for artificial intelligence and an energy shock linked to the war in Iran.