According to informed sources, the Bank of Japan is inclined to raise the policy interest rate by 25 basis points at the monetary policy meeting on September 17-18, increasing it from the current approximately 1.0% to 1.25%. The market has nearly fully priced in this path, with the core debate not being whether to raise rates, but whether to raise them by 50 basis points in one go.

Sources close to the decision-making body indicate that near-term price pressures are considered manageable and far from the intensity seen at the peak of the 1980s asset bubble. The central bank is reluctant to implement an extraordinary 50 basis point hike this month to avoid shocking households and businesses that have long been accustomed to near-zero interest rates. If a rate hike occurs, it will be done in the conventional 25 basis points to observe the lagged effects of the previous five rate hikes on consumption, hiring, and bank lending.

Governor Kazuo Ueda stated during the G20 that the meeting this month will discuss whether the probability of economic scenarios materializing has increased and whether the risks of rising prices have intensified. He emphasized that financial conditions remain accommodative and expressed a desire to continue raising rates while assessing the cumulative tightening's impact on the real economy. He confirmed he had met with U.S. Treasury Secretary Janet Yellen but did not disclose the content; Yellen had previously publicly urged Japan to take "decisive" monetary measures to address the weak yen.

Policy board member Takeda Haruhiko had proposed raising the overnight rate to 1.25% at the July meeting, which was rejected by a vote of 8 to 1. He subsequently stated that 2026 is a turning point for policy and advocated for abandoning the fixed semi-annual rhythm, suggesting a more flexible approach to rate hikes in response to Middle Eastern conflicts, import costs, and global demand shocks. The minutes from the July meeting showed that some members warned that potential inflation could exceed the 2% target, and delaying action could amplify the risk of overshooting.

The policy interest rate was raised to approximately 1.0% at the June meeting, the highest since 1995; at that time, Ueda was absent due to illness, and the vote was 7 to 1, with the only dissenting vote coming from the dovish new member Asada. A Reuters survey of economists showed that the expectation of a rate hike to 1.25% in September rose from 5% in July to 57% in August. The money market has priced in a 25 basis point hike next month and nearly fully priced in another increase to 1.5% in January next year.

Mechanically, this is an event-driven expectation trade rather than a finalized decision: shorting the yen and pricing in short-term rate hikes benefits from the narrative of "small step rate hikes + accelerated pace"; long-term Japanese government bonds are under pressure due to market concerns about subsequent quarterly rate hikes, with yields on 20-year and 30-year bonds rebounding before the auction. Bank net interest margins are expected to improve, while the financing costs for highly leveraged real estate and small and medium-sized enterprises rise. If only a 25 basis point hike occurs instead of 50 basis points, bond market volatility can be contained, but if the yen weakens again due to "insufficient magnitude," import inflation may force faster action next time.

Overnight index swaps show that the two-year forward rate briefly touched record highs before falling back to around 2.3%; the two-year government bond yield rose to its highest level since 1995 after hawkish committee member comments. The majority of analysis paths suggest a rise to 1.25% in September, followed by another increase to 1.50% in December or January next year, shifting from approximately two hikes per year to nearly one per quarter.

Source: Public Information