Bank of Japan preview: Set to raise rates 25 bps

Summary

Bank of Japan (BoJ) policymakers are set to raise rates 25 bps this week, a now consensus view but a stance we took well before financial markets fully priced tighter BoJ monetary policy. Markets fully digesting a BoJ December rate hike likely means the Japanese yen will fall short of hitting our YE-2025 USDJPY target; however, no element of surprise also means emerging market currencies should be more protected and not experience much post-hike volatility, a different dynamic relative to last year's BoJ August hike that injected volatility across many high-yielding emerging currencies as the yen funded carry trade unwound.

Looking ahead, even before we hear from BoJ policymakers on the outlook for monetary policy, we are adjusting our BoJ forecast profile to now include another 25 bps rate hike in Q3-2026. Financial markets are priced for the BoJ to deliver a rate hike closer to the end of next year, which puts our updated BoJ outlook moderately out of consensus on the more hawkish side. Our revised view leads us to believe the yen may be more resilient in H2-2026 than we originally forecast on diverging paths for BoJ-Fed monetary policy.

Bank of Japan preview

Bank of Japan (BoJ) policymakers will make their final monetary policy decision of 2025 at the end of this week, and we—alongside the broader consensus—expect a 25 bps rate hike to be delivered. We have been steadfast in our view that the BoJ would raise rates this week, a forecast we highlighted in our 2026 Annual Economic Outlook well before financial markets fully priced a December rate hike. Our rationale for a hike came down to our assessment of underlying economic fundamentals in Japan which—despite political preference for easier monetary policy after Prime Minister Takaichi's election earlier this year—we felt were consistent with tighter BoJ monetary policy. Since we published our year ahead outlook, economic fundamentals, in our view, have become more consistent with higher interest rates. This conviction stems from wage hikes that are above the current pace of inflation, fiscal stimulus deployed by the Takaichi administration and leading indicators that suggest activity is still firm. Adding to our conviction is a Japanese yen that has broadly remained on the defensive and has not participated in the dollar depreciation trend as much as peer G10 currencies.

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