Japanese Markets Defy Convention as BOJ Raises Rates to 31-Year High

Tokyo markets exhibited an unusual reaction on Friday following the Bank of Japan’s decision to raise its benchmark interest rate, pushing it to the highest level since 1995. Typically, such a tightening move strengthens the currency, elevates bond yields, and weighs on equities. Instead, the yen depreciated, bond yields retreated, and the Nikkei 225 advanced by 1.5%.

The policy rate was increased by 25 basis points to 1.25%, marking the second hike in just three months. However, the market response was driven by a divided committee and a lack of updated economic projections that might have suggested a more aggressive stance.

The board vote split 7-2, with members Toichiro Asada and Ayano Sato dissenting in favor of maintaining current rates. Asada cited core inflation remaining below the 2% target, noting that August figures came in at 1.7%, down from 1.8% in July. Sato similarly argued that recent economic and price trends had not accelerated sufficiently to warrant a hike.

“The two dissenting votes in favor of keeping rates unchanged came as a surprise,” said Hirofumi Suzuki, chief foreign exchange strategist at Sumitomo Mitsui Banking Corporation. The dissent signaled to investors that the central bank may not pursue a hawkish trajectory.

Masahiko Loo, a senior fixed income strategist at State Street Investment Management, highlighted that the absence of a revised economic outlook limited the BOJ’s ability to reinforce a hawkish message. Shigeto Nagai of Oxford Economics agreed, noting the softer tone. Nagai suggested the split reflected political nuances, implying that Prime Minister Sanae Takaichi was not fully aligned with U.S. demands for faster rate increases. Reports earlier indicated that U.S. Treasury Secretary Scott Bessent had urged Japanese Finance Minister Satsuki Katayama during a May meeting to support higher interest rates.

Following the announcement, the yen weakened past the 157 level against the dollar. The yield on the 10-year Japanese Government Bond also slipped. Financial markets had anticipated a stronger forward guidance, but the statement retained language similar to the July quarterly outlook, which analysts described as less hawkish than hoped.

Despite the cautious immediate reaction, experts predict further tightening. Another rate increase is widely expected around December. Loo stated that Governor Kazuo Ueda is likely to emphasize that future meetings remain “live,” shifting the debate from whether rates will rise to how high they will ultimately go.

The BOJ acknowledged that growth may decelerate due to elevated oil prices linked to conflicts in the Middle East, though it reaffirmed its commitment to raising rates as conditions permit. Sam Jochim, an economist at EFG International, projected rates could rise approximately every three months as underlying inflation nears the 2% target, potentially reaching a terminal rate between 1.75% and 2% by 2027. Conversely, Stefan Angrick of Moody’s Analytics forecasted a hike around the turn of the year but warned that weak demand-driven inflation and sluggish real wage growth would constrain further moves.