BOJ Maintains Interest Rate at 1.25%, Rising Inflation Risks Keep Further Tightening in Focus

The BOJ voted 8:1 to keep its policy rate unchanged at 1.25%, following the 25-bps hike at its previous meeting. While the policy decision was widely anticipated, one member, Hajime Takata, dissented in favor of a further 25-bps hike to 1.50%, citing changing inflation dynamics and the need for faster policy normalization. Growth is expected to remain moderate, with the Middle East conflict and higher energy and raw material prices weighing on activity. Meanwhile, yen depreciation and wage pressures are likely to keep inflation above the 2% target. The BOJ remains on a tightening path, although the pace of further hikes will depend on evolving growth and inflation dynamics.

Growth Outlook Moderates Amid Persistent Inflation Pressures

Japan’s economy is expected to grow moderately in FY26, as higher energy and raw material prices amid the Middle East situation weigh on activity, corporate profitability and household real incomes. Government support, accommodative financial conditions and strong global AIrelated demand should provide some cushion, with growth expected to strengthen as cost pressures ease. The BOJ has lowered its FY27 growth forecast by 0.1 percentage point to 0.7%, while still expecting a gradual recovery.

Inflation is expected to remain elevated due to higher crude oil prices, yen depreciation, rising input costs and food prices. Tight labor market conditions and persistent shortages are supporting wage growth, while firms are passing higher costs on to consumers. The BOJ has raised its FY27 core CPI forecast by 0.2 percentage point to 2.6%, before easing to 2.0% in FY28. Persistent inflation keeps further policy tightening in focus.

Yen Remains Under Pressure as US-Japan Yield Differential Widens

The US-Japan 10-year yield spread has widened to 214 bps from 195 bps at the previous BOJ meeting. Global yields remain elevated amid inflation concerns due to higher energy prices and increased government and corporate borrowing, particularly for AI investment. US Treasury yields have risen 80 bps to 4.92% since end-2025, against a 72 bps rise in JGB yields to 2.78%, widening the yield advantage of US assets. This has kept the yen under pressure despite BOJ rate hikes, raising import costs and adding to inflationary pressures, while increasing pressure on the BOJ to accelerate policy normalization.

Market Reaction

Japanese Markets remained under pressure largely because global AI rout as monetary policy broadly came in line with expectation, with the Nikkei 225 down ~2.34% today. Meanwhile, USD/JPY appreciated to 157.3 for a third consecutive session, while the 10-year JGB yield edged lower to 2.78%.

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