Policymakers' hawkish statements + inflation pressures strengthen expectations for Bank of Japan interest rate hikes, leading to increases in Japanese bond yields and the yen

The Zhitong Finance APP learned that hawkish remarks from Bank of Japan officials and persistently high inflation are strengthening market expectations for a rate hike by the Bank of Japan, pushing Japanese bond yields to multi-year highs. Data shows that the benchmark 10-year Japanese government bond yield rose by 2.5 basis points on Monday to 1.375%, the highest level since 2010; the 5-year Japanese government bond yield also increased by 3.5 basis points to 1.040%, the highest level since 2008. Meanwhile, as expectations for a rate hike by the Bank of Japan heat up, the yen has strengthened, with the USD/JPY exchange rate falling to 151.74 yen per dollar.

In January, the Bank of Japan announced a 25 basis point rate hike, raising the policy benchmark rate to 0.5%. This marks the third rate hike by the Bank of Japan in less than a year, pushing the policy benchmark rate to its highest level since 2008.

After announcing the rate decision, the Bank of Japan hinted at further rate hikes, as the Japanese economy is moving towards sustainably achieving the 2% inflation target. Additionally, in the quarterly outlook report released on January 24, the Bank of Japan analyzed how long-term labor shortages are leading to rising wage-driven inflation, providing justification for further rate hikes.

It is noteworthy that in recent times, policymakers at the Bank of Japan have repeatedly signaled a hawkish stance. Bank of Japan Deputy Governor Ryozo Himino stated in January that it is "abnormal" for Japan's real interest rates to remain negative for too long. Bank of Japan board member Naoki Tamura also mentioned earlier this month that the Bank of Japan must raise rates to at least 1% before early 2026.

Furthermore, former Bank of Japan board member Makoto Sakurai, who maintains close ties with current policymakers, expects the Bank of Japan to raise the policy rate to at least 1.5% within the next two years. The market is also watching whether Bank of Japan board member Hajime Takata will signal further rate hikes in his speech this Wednesday.

In addition to the hawkish statements from the Bank of Japan, strong economic data and signs of persistent inflationary pressure in Japan have also led to heightened market expectations for a rate hike by the Bank of Japan. Data released by the Cabinet Office on Monday showed that the annualized quarter-on-quarter GDP growth rate for the fourth quarter of last year was 2.8%, up from a revised 1.7% in the previous quarter and significantly exceeding the market's general expectation of 1.1%. Data released last week indicated that Japan's wholesale inflation rate surged to a seven-month high of 4.2% in January, accelerating for the fifth consecutive month—although the Bank of Japan's policy target focuses on consumer inflation rather than wholesale inflation, rising wholesale prices are likely to be transmitted to the prices of goods and services purchased by households.

The market currently expects an approximately 80% chance that the Bank of Japan will raise the policy rate to 0.75% (i.e., a 25 basis point hike) by July, and the expectation for a rate hike before September has been fully priced in. ** A private sector survey shows that most economists expect the Bank of Japan's next interest rate hike to occur in the second half of this year.

Mitsubishi UFJ Morgan Stanley Securities currently expects the Bank of Japan to raise the policy interest rate from the current 0.5% to 0.75% in July, rather than the previously anticipated October to December timeframe. The firm has also brought forward its forecast for the Bank of Japan's next rate hike, predicting an increase to 1.0% in January 2026, citing that "the persistence of price pressures has exceeded expectations."

Former Bank of Japan official Nobuyasu Atago is more optimistic, believing that given the Bank of Japan's increasing focus on the risks of inflation exceeding expectations, a rate hike could occur at the policy meeting on April 30 to May 1. He remarked on the recent rise in Japanese bond yields, stating: "The Bank of Japan's next rate hike may come unexpectedly soon. The market may have already begun to digest this."

External factors may also impact the prospects for a Bank of Japan rate hike. Some analysts believe that U.S. President Trump's focus on addressing trade imbalances is favorable for a Bank of Japan rate hike, as it would weaken the Japanese government's long-standing resistance to a stronger yen and rate hikes, allowing for a more lenient stance on yen appreciation. Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities, stated: "The Japanese government is aware of the political risk of being seen (by the U.S.) as 'tolerating yen depreciation.'"