Japan hikes rates to highest since 2008 as sustained inflation, rising wages

The Bank of Japan hiked rates by 25 basis points Friday to 0.5%, bringing its policy rate to the highest level since 2008, as it seeks to normalize its monetary policy amid signs of sustained inflation and rising wages.

The move comes in line with expectations from CNBC’s survey, where an overwhelming majority of economists predicted a hike.

The BOJ in its statement revealed that the decision was a 8-1 split, with board member Toyoaki Nakamura dissenting on raising rates.

Nakamura said the central bank should only tweak policy after confirming a rise in firms’ earning power from reports that would be out by the next monetary policy meeting.

Following the decision, the Japanese yen strengthened 0.6% to trade at 155.12 against the dollar, while country’s benchmark Nikkei 225 stock index rose marginally.

The yield on the 10-year Japanese government bonds climbed 2.5 basis points to 1.23%.

The Bank of Japan has long stated that a “virtuous cycle” where higher salaries fuel growth in prices was needed for it to raise rates.

Before the meeting, senior BOJ officials, including governor Kazuo Ueda and Deputy Governor Ryozo Himino, had indicated the central bank’s willingness to raise rates.

The BOJ will be watching closely the “shunto” wage negotiations, and hopes to see “strong wage hikes” in the 2025 fiscal year, Himino said in a speech to business leaders on Jan. 14.

In its Friday statement, the central bank noted that there were “many views expressed by firms stating that they will continue to raise wages steadily in this year’s annual spring labor-management wage negotiations, following the solid wage increases last year,” due to improving corporate profits and a tight labor market.

The head of Japanese Trade Union Confederation — Rengo — said that annual pay increases this year must exceed the 5.1% secured last year because real wages continue to fall, Reuters reported.

President Tomoko Yoshino said Rengo was formally seeking wage increases of at least 5% in this year’s “shunto” wage negotiations, and is targeting hikes of at least 6% for smaller firms to narrow the income gap with workers at bigger companies.

BOJ pointed out that with wages continuing to rise, underlying inflation had been increasing gradually toward 2%.

CPI numbers released earlier Friday showed headline inflation hit its highest since January 2023 at 3.6%, year on year, in December. Core inflation rose to a 16-month high of 3%.

BOJ forecast that the headline inflation rate was likely to be at around 2.5% for its fiscal year ending March 2026, due factors such as higher import prices stemming from the yen’s depreciation.

In a note on Jan. 21, Vincent Chung, co-portfolio manager for diversified income bond strategy at T. Rowe Price, said that moving forward, a rate increase will be followed by “a series of gradual hikes, potentially bringing the policy rate to 1% by the end of the year.”

He added that the policy rate could even exceed 1%, as this is closer to the lower end of the BOJ’s neutral rate range.

In September, BOJ board member Naoki Tamura said the neutral rate “would be at least around 1 percent,” although BOJ does not have an official neutral rate forecast.

Chung noted that while Japanese officials have indicated that yen volatility has been significant, any substantial currency intervention akin to last year seems unlikely.

Last July, the yen hit its weakest level against the dollar since 1986, reaching 161.96. Japanese authorities later confirmed that they spent 5.53 trillion yen, or $36.8 billion, to shore up the yen in July.

Japan spent over 15.32 trillion yen ($97.06 billion) to shore up the currency over the course of 2024.

Chung said inflation in the U.S. might increase later this quarter, and coupled with sustained economic growth, this could exert upward pressure on yields, which could strengthen the dollar — weakening the yen.

“Investors should also consider that with potential major policy shifts in trade and the Fed nearing a pause, the two-sided risk to growth is likely greater this year than in 2024. Consequently, we expect realized volatility in USD/JPY to remain high in 2025,” he said.