Japanese markets defy expectations after central bank rate hike

Japanese financial markets exhibited an unusual response on Friday following the Bank of Japan’s decision to raise benchmark interest rates to their highest level in three decades. Contrary to standard economic theory, which suggests that rate increases typically strengthen a currency, elevate bond yields, and weigh on equities, the Japanese market moved in the opposite direction. The yen weakened beyond 157 against the US dollar, the yield on the 10-year Japanese Government Bond declined, and the Nikkei 225 index climbed by 1.5 per cent. This reaction occurred as the central bank lifted its policy rate to 1.25 per cent, a level not seen since 1995 and just three months after the previous increase.

Market analysts attributed this counterintuitive movement primarily to the split decision taken by the Bank of Japan’s board. The vote was recorded as seven to two, with board members Toichiro Asada and Ayano Sato dissenting from the majority view. Their opposition, which favoured keeping rates unchanged, surprised many observers and signalled that the institution may not adopt an overly hawkish stance. Hirofumi Suzuki, chief FX strategist at Sumitomo Mitsui Banking Corporation, noted that the two dissenting votes were unexpected. Asada argued that the economic situation might not be robust enough for further tightening, pointing to core inflation for August standing at 1.7 per cent, down from 1.8 per cent in July. Sato similarly observed that current economic and price developments had not substantially accelerated compared to previous periods.

The market reaction was further influenced by the absence of an updated outlook report accompanying the rate hike. Masahiko Loo, senior fixed income strategist at State Street Investment Management, explained that this limited the bank’s ability to reinforce a hawkish message through revised forecasts. Shigeto Nagai, head of Japan economics at Oxford Economics, echoed this view, adding that the dissenters indicated Prime Minister Sanae Takaichi was not convinced to accede to US requests for faster rate hikes. Reuters reported that US Treasury Secretary Scott Bessent had previously stressed the need for higher rates during a meeting with Japanese Finance Minister Satsuki Katayama in May. Nagai added that the tone of the statement was less hawkish than financial markets had hoped, as the language remained similar to the quarterly outlook report published in July.

Looking ahead, experts believe another rate increase is likely in December. Kazuo Ueda, the Bank of Japan’s governor, is expected to emphasise that every forthcoming meeting remains live for policy action. The debate has shifted from whether the bank will hike rates to how far they will ultimately go. The central bank stated it would continue raising rates as economic and price conditions develop, while acknowledging that growth was likely to decelerate due to high oil prices stemming from the Middle East conflict. Sam Jochim, an economist at EFG International, suggested rates could rise roughly once every three months as underlying inflation approaches 2 per cent, with a terminal rate between 1.75 per cent and 2 per cent expected in 2027. However, the bank has not forecast a specific terminal rate, maintaining instead that it will conduct monetary policy as appropriate to stabilise underlying inflation at its 2 per cent target. Stefan Angrick, head of Asia-Pacific economics at Moody’s Analytics, expects another increase around the turn of the year but noted that weak demand-driven inflation and disappointing real-wage growth would limit subsequent moves.