Bank of Japan expected to raise interest rates amid inflation concerns

The Bank of Japan (BOJ) is anticipated to vote for a rate hike during its meeting on Friday, according to a foreign news agency.

The BOJ's policy rate is likely to be raised from the current 0.25% to 0.5%, the highest level since October 2008.

This move is part of the bank's ongoing policy normalization process as inflation remains above the BOJ's 2% target and wage increases by domestic companies continue to spread.

The bank had considered forgoing any hike if U.S. President Donald Trump's inauguration led to market volatility, but several officials believe that the current situation allows for the expected rate increase.

Fitch expects the BOJ to raise its policy rate to 1.0% by the end of 2025, while continuing to taper its purchases of Japanese government bonds (JGBs) as per the schedule announced in July 2024.

This outlook is supported by resilient wage price dynamics, with scheduled cash earnings growth turning broadly positive in real terms in the second half of 2024 and core inflation remaining above the BOJ's 2% target.

Despite pressure on public finances from higher interest rates, Fitch views Japan's credit profile as benefiting from a stronger inflation outlook than historically.

However, risks are skewed towards faster policy tightening by the BOJ, particularly if the Japanese yen depreciates further in response to trade and monetary policy developments in the U.S.

Japan's much lower interest rates compared with developed market peers have contributed to yen weakness, impacting household confidence.

Political dynamics have shifted significantly with the re-election of Shigeru Ishiba of the Liberal Democratic Party (LDP) as prime minister, leading a minority government following the LDP's loss of a parliamentary majority in October's lower house elections.

This could result in looser fiscal policy, as opposition parties, particularly the Democratic Party of the People (DPP), tend to be more fiscally dovish than the LDP.

The DPP, which has expressed willingness to work with the LDP on a case-by-case basis, has championed tax cuts that could reduce fiscal revenues by about 1.5% of GDP.

Agencies forecast real GDP growth to rebound to 1.2% in 2025, from -0.2% in 2024, before settling at 0.5% in 2026, in line with estimates of Japan's potential growth.

Weak economic activity in early 2024 was attributed to a testing scandal at Japanese automakers and the Noto Peninsula earthquake, but consumption and investment drove a recovery in the latter part of the year.

Inbound tourism has been robust, with visitor arrivals in 2024 approximately 14% above 2019 levels.