BOJ hikes to 1.25%. The highest in 31 years.

At its Monetary Policy Meeting on September 17–18, the BOJ raised the policy rate (the target for the uncollateralized overnight call rate) by 0.25% to around 1.25%. The vote was 7 in favor, 2 against. The new rate takes effect on September 24, with the interest rate applied under the Complementary Deposit Facility at 1.25% and the basic loan rate at 1.5%. At 1.25%, the rate is at its highest since 1995, roughly 31 years.

It comes just three months after June's hike (0.75% → 1.0%), the shortest interval between moves since the bubble era. In its statement, the BOJ said underlying inflation is approaching 2% while financial conditions remain accommodative, and spelled out that it "will continue to raise the policy interest rate." At his press conference Governor Ueda said "the phase of policy has changed," adding that while he has "no particular interval in mind" for the pace ahead, consecutive hikes or a larger 0.5% move cannot be ruled out, depending on prices.

For a long time the BOJ's policy rate sat in negative territory at −0.1%. The turning point was the exit from negative rates in March 2024. It then climbed the staircase one step at a time — 0.25% in July of that year, 0.5% in January 2025, 0.75% in December 2025 and 1.0% in June 2026 — and after a hold in July, to 1.25% in September. That is a level unseen since 1995.

While other economies are in a phase of "coming down the mountain," Japan is at the stage of "finally starting to climb." Even so, 1.25% is still quite low compared with the US (3.875%) or the UK (3.75%). This large rate gap has been the main driver of the persistent weak yen. That said, 1.25% is a milestone in one respect: it is the first time the rate has risen above the lower bound of the estimated neutral-rate range (nominal 1.1–2.5%) that the BOJ presented in March.

August core CPI (excluding fresh food) was +1.7% year-on-year (July: +1.8%), an eighth straight month in the 1% range. It remains below the 2% target. The BOJ hiked all the same because it is looking not at the outturn but at the outlook for prices ahead. The July Outlook Report presented the view that inflation will run "clearly above 2%" from the second half of fiscal 2026.

In its statement the BOJ explained that core CPI is rising moderately, as price increases in inter-company transactions feed through to consumer prices and the pass-through of wage increases continues. It added that medium- to long-term inflation expectations have also risen, leaving underlying inflation close to 2%. Behind this, on top of higher crude oil and the weak yen, are price rises in semiconductors and other goods driven by AI-related demand. It was wariness about the risk of inflation overshooting 2% that, more than anything, led to this hike.

Beyond rates, the BOJ is also advancing normalization by reducing the purchases of the Japanese government bonds (JGBs) it has kept buying in large volumes. The plan is to fix the reduction at around 2 trillion yen per month from April 2027 onward, proceeding while heeding a sharp rise in long-term yields and prioritizing market stability.

The BOJ is reducing its purchase amount step by step each quarter, trimming to around 2 trillion yen per month in January–March 2027, after which it will halt the reductions. Raise rates while avoiding sudden swings in the JGB market — the challenge for the BOJ is to advance this "two-front normalization" carefully, so as not to surprise the market.

Monetary policy is decided by majority vote of the 9 Policy Board members at the Monetary Policy Meetings held 8 times a year. The composition is 1 Governor, 2 Deputy Governors and 6 other members. This time all 9 attended, and the hike was decided 7 in favor, 2 against. Both dissenters argued for keeping rates unchanged.

Voting in favor were Governor Ueda, Deputy Governors Himino and Uchida, and board members Takata, Tamura, Koeda and Masu. Against were Asada and Sato, both taking the position that "rates should be kept on hold for now." Separately, Takata and Tamura dissented on the wording of the price outlook, arguing that "underlying inflation has already reached the target," leaving the board split from both the dovish and the hawkish side.

There are 8 meetings a year. At the January, April, July and October meetings, the "Outlook Report" presenting the economic and price outlook is published, drawing particular market attention. With this meeting over, the next is October 29–30 (Outlook Report published).

The market's biggest interest is when the next hike comes. Because Governor Ueda said he has "no particular interval in mind" while declining to rule out back-to-back hikes, a further hike at the October meeting is also on the radar as an option. The next Outlook Report is due to be published at the October 29–30 meeting. Moves in prices, wages and the exchange rate until then will sway the decision.

The BOJ's rate heavily influences the dollar-yen exchange rate. As Japan's rates rise and the gap with the US narrows, in principle a force toward a stronger yen should be at work. This time, however, Governor Ueda's remark that he has "no particular interval in mind" for the pace of further hikes was read as dovish, and the yen struggled to gain. The US-Japan rate gap remains wide.