The BOJ stated that it will continue to raise the policy rate if economic and price trends are in line with its forecasts, and as the economy and prices improve. It noted that risks to the economic outlook are roughly balanced, and risks to the inflation outlook are also roughly balanced. Outlook risks include the impact of trade policies on overseas economies, wage and price-setting behavior of domestic firms, and developments in financial and foreign exchange markets.

 

At the same time, the BOJ updated its quarterly economic growth forecasts. It projects the median core Consumer Price Index (CPI) for fiscal years 2025–2027 at 2.7%, 1.9%, and 2.0% respectively, compared with the October forecast of 2.7%, 1.8%, and 2.0%. The median real GDP growth for fiscal years 2025–2027 is expected at 0.9%, 1.0%, and 0.8% respectively, versus the October forecast of 0.7%, 0.7%, and 1.0%. The BOJ said core consumer inflation is likely to slow to below 2% in the first half of this year, and underlying core consumer inflation may be broadly in line with the 2% target in the second half of the 2025–2027 fiscal year forecast period.

 

Data released earlier today showed that Japan’s core CPI (excluding fresh food) rose 2.4% year-on-year in December last year, slowing from a 3% increase in November, matching the median forecast of economists. The annual pace of overall CPI in December fell to 2.1% from 2.9% the previous month, slightly below the expected 2.2%.

 

Shinichiro Kobayashi, Chief Economist at Mitsubishi UFJ Research and Consulting, said: “The slowdown in inflation is due to policy effects and the end of the price hike cycle. Although growth slowed at the end of the year, food prices rose at a fairly high rate throughout the year, and consumers still feel inflation very strongly.”

 

 

After the rate decision was announced, the yen’s decline against the US dollar widened to 158.61. The 160 level is seen as roughly the critical point where the BOJ intervened multiple times in 2024. The BOJ also emphasized today that it will monitor situations where yen exchange rate movements are more likely to affect inflation.

 

Although the BOJ was the only major central bank to raise interest rates twice last year, it still failed to reverse the yen’s weakness. Japan’s interest rate level remains the second-lowest among major economies, after Switzerland. Since early October last year, the yen has fallen about 7% against the US dollar, the largest drop among major currencies.

 

According to people familiar with the matter, BOJ officials are paying more attention to the impact of yen depreciation on inflation, as further yen weakness could push up price levels and thus accelerate the pace of future rate hikes. Naka Matsuzawa, Chief Strategist at Nomura Securities, said: “The BOJ may signal that the bar for the next rate hike will not be high to avoid exacerbating yen depreciation. They may leave room to act as early as April.”

 

Pricing in the overnight index swap market shows traders see about a 58% chance of the BOJ’s next rate hike in April, up from around 38% predicted in December last year. However, among economists surveyed, June–July remain the most popular expected timing for a rate hike. Akira Hoshino, Head of Markets at Citi Japan, said that if yen weakness persists, the BOJ may raise rates three times this year, lifting the policy rate from the current 0.5% to 1%, double the existing level. “Once the USD/JPY breaks above 160, it is highly likely that the BOJ will hike rates by 25 basis points to 1% in April. If the exchange rate remains low, the bank may raise rates again in July, and a third adjustment of the same magnitude before the end of the year cannot be ruled out,” he said.

 

Last week, Japanese Finance Minister Satsuki Katayama and senior monetary policy official Jun Mimura both stated that the Japanese government is paying increasing attention to the matter and stepping up verbal warnings. Daisuke Karakama, Chief Market Economist at Mizuho Bank, said it is an open secret that the yen plays a pivotal role in Japan’s monetary policy decisions. However, it is “deeply worrying” that the yen may again play such a role at a time when the government needs to defend its currency. The final choice comes down to one of two pains: higher interest rates or a weaker yen. Since one must be endured, the final decision may lie with politicians, not the central bank.

 

However, Tomoo Kinoshita, Global Market Strategist at Invesco Japan, told Yicai Global: “As the interest rate gap between Japan and the US continues to narrow, the yen still has appreciation momentum, reflecting market expectations for Fed rate cuts and further policy normalization by the BOJ.”

 

 

On the same day the BOJ announced its rate decision, Japanese Prime Minister Sanae Takaichi said she would dissolve the House of Representatives, paving the way for an early general election to be held on February 8. Markets speculate that the Liberal Democratic Party is still highly likely to win the election, which would give the government more room for expansionary fiscal spending. Affected by the news, Japanese government bond (JGB) yields surged earlier this week, with 5-year, 30-year and 40-year JGB yields all hitting record highs.

 

After today’s decision, the 10-year JGB yield stood at 2.239%, still hovering near earlier weekly highs. Tomoo Kinoshita told reporters: “Sanae Takaichi’s plan to sharply increase government fiscal spending while cutting taxes has raised concerns among bond investors. The 10-year JGB yield once rose to 2.35% on January 20, a very significant fluctuation for JGBs, long regarded as one of the world’s most stable and safe asset classes.”

 

Takaichi’s policies to drive economic reflation in 2026 are positive for Japanese stocks and the yen, but relatively negative for JGBs. At the same time, she announced a campaign pledge to cut the food consumption tax from the current 8% to zero over the next two years. The fiscal cost of scrapping the tax is estimated at about ¥5 trillion per year, equivalent to about 0.8% of Japan’s 2024 GDP. Given that the Japanese government has not clearly specified how the tax relief will be funded, markets widely expect the government to issue more JGBs to fill the fiscal gap. More importantly, it is widely believed that the temporary food tax cut will face high political resistance and be difficult to reinstate after two years.

 

“If these tax cuts eventually become permanent policy, Japan’s fiscal position will come under further pressure. By the end of 2025, the ratio of Japan’s total government debt to GDP had reached a high of 229.6%. Therefore, concerns about Japan’s future fiscal outlook are pushing up long-term bond yields, and higher debt interest costs in turn exacerbate fiscal pressure.” Thus, Kinoshita said: “In the short term, market focus is expected to shift to possible market stabilization measures that may be launched by Japan’s Ministry of Finance and the BOJ, such as the Ministry of Finance buying back long-term JGBs, or the BOJ adjusting the pace of its quantitative tightening policy. The BOJ may slow the pace of balance sheet reduction to stabilize the JGB market, but it may also leave the yen exposed to further depreciation risks. Longer term, the outcome of Japan’s House of Representatives election scheduled for February 8 will be a key factor affecting market trends. Once the election results are out, the governing structure and policy direction will become clearer, and the JGB market may gradually stabilize.”

 

After the rate decision was announced, the Nikkei 225 Index extended its gains. Kinoshita told reporters: “In sharp contrast to Japanese bond investors, Japanese stock investors have reacted positively to Takaichi’s dissolution of the House of Representatives and policies to promote economic reflation. In 2026, as inflation pressure eases and real wage growth returns to positive territory, Japan’s economy may recover driven by domestic demand, creating a favorable macro environment for stock market performance.”

 

He added that corporate governance reform in Japan has been underway for more than a decade. In 2026, the Tokyo Stock Exchange will take the final step in its restructuring plan and initiate delisting procedures for companies that still fail to achieve sufficient improvements. Japan’s Financial Services Agency plans to revise the Corporate Governance Code in 2026, with key agendas including effective capital allocation and better use of cash for investment. He said continued progress in corporate governance is expected to boost capital efficiency and profitability, thereby supporting the long-term performance of Japanese stocks.