The Bank of Japan surprised the market by hiking its key interest rate to 0.5%, the highest level in 17 years, and adopting a notably more upbeat outlook on inflation. Though largely expected, the rate hike stoked speculation about further increases while giving the yen a much-needed boost.

Governor Kazuo Ueda and his team unveiled the decision at the end of a two-day meeting, justifying the timing with updated inflation forecasts and a need to monitor the market reaction to Donald Trump’s return to the Oval Office. The BOJ subtly pointed out the current “relative stability” of global financial markets, indicating they’re keeping a close eye on Trump’s early days.

The yen rallied against the dollar, reaching 155.01, while Japan’s 10-year government bond yield climbed to 1.23%. Meanwhile, the Nikkei 225 index wobbled before inching back into positive territory. This hawkish statement hints at more rate hikes, potentially by May, once wage pressures solidify.

Friday’s move marks the BOJ’s third rate hike under Ueda in less than a year. It comes as inflationary pressures grow, with core consumer prices up 3%—well above the BOJ’s 2% target. The central bank revised its inflation projections upwards, further fuelling expectations of a steady pace of rate increases.

However, some warn that a hasty approach could lead to unwanted yen appreciation, threatening the BOJ’s inflation target. Indeed, if the yen strengthens too quickly, falling import prices could derail the inflation goal. Conversely, a weak yen pressures household budgets, easing the path for more hikes.

While this move underscores the BOJ’s departure from its ultra-loose monetary policy, it also highlights its growing alignment with global peers. Japan’s rates are now inching closer to those of other nations, granting the BOJ more conventional policy tools for future crises. Yet, it remains one of the last bastions of low rates among major central banks, sharing this dubious honour with the Swiss National Bank.

BOJ may raise rates roughly every six months, aiming for 1% by March 2026. The timing of this hike reflects an effort to remove monetary policy distractions as Prime Minister Shigeru Ishiba works to secure budget approval and consolidate his leadership ahead of the summer elections.
While inflation has proven to be a political nightmare for global leaders, Japan’s relatively stable environment provides a rare opportunity for the BOJ. The question remains: will it navigate these waters with finesse, or are choppier seas ahead?