The Bank of Japan has raised its target for the uncollateralized overnight call rate by 25 basis points to 1.25%, the highest since April 1995, in line with economists' expectations. The policy committee voted 7 to 2 in favor, with members Toyoda and Sato opposing. The new rate will take effect on September 24.

This is the shortest interval between rate hikes since exiting negative interest rates in March 2024, just three months since the last increase, whereas previously hikes occurred approximately every six months. The statement noted that the economy and prices are generally in line with the baseline, but there is a risk of core inflation deviating upwards from the 2% target, with price transmission from businesses to consumers and wages to prices continuing. The corporate price index rose 7.6% year-on-year in August, exceeding 7% for the third consecutive month.

Following the announcement, the yen briefly weakened to around 156.6 to 156.9 per dollar, and the yield on 10-year government bonds fell about 5 basis points to around 2.95%. The market interpreted the two opposing votes as a sign that the committee is not united on accelerating the pace of rate hikes, rather than doubting the rate hike itself. External pressures such as conflicts in the Middle East, oil prices, and a weak yen were noted; there have been public calls from Washington for Japan to normalize its policies. The estimated neutral interest rate range is about 1.1% to 2.5%, with 1.25% now at the lower end.

Members Toyoda and Sato argued that inflation and growth have not accelerated to the point where tightening is immediately necessary. Other members expressed dissatisfaction with the outlook wording from the opposite perspective, believing that core inflation is already in line with the 2% target and could be raised more quickly. A Reuters poll anticipates the rate to reach 1.5% by the end of the year and around 1.75% by the second quarter of 2027. The press conference with Governor Ueda will be the next point of observation. The statement indicated that the accommodative financial environment will be maintained even after the rate hike.

Mechanically, this raises the cost of yen carry trade funding: buying involves repricing domestic bonds and deposits, while selling involves cross-border arbitrage funded in yen. Local banks benefit from a wider net interest margin; high-leverage carry trades and manufacturers reliant on imported energy face pressure. The rate hike met expectations but the yen depreciated against the dollar, indicating that pricing had already been anticipated, trading on the opposing votes and the wording of 'still accommodative.'

Additionally, when the rate was raised to 1.0% in June, it was already referred to as a 31-year high; this latest hike pushes the peak higher and compresses the interval between hikes to one quarter. With upstream prices consistently above 7%, the committee's choice to act before the consumer end fully adjusts is justified.

Source: Public Information