The Bank of Japan decided to raise its policy rate by 25bp at the September 18 Monetary Policy Meeting. The hike comes just three months after the previous increase in June and represents an acceleration in the pace of tightening. Reflecting this shift in the Bank's stance, Governor Ueda referred to "a new policy phase" at his press conference.

With its rate hikes since March 2024, the BOJ has sought to reduce the degree of monetary accommodation by gradually lifting the policy rate toward a more neutral level, reflecting growing confidence that underlying inflation will rise toward the 2% target.

But the Bank has argued that with underlying inflation now approaching 2%, an upside deviation in inflation driven by such factors as higher oil prices could push underlying inflation above the target, thus creating a need for preemptive measures to mitigate that risk. This is what Governor Ueda means by “a new policy phase” and explains the acceleration in the pace of rate hikes.

When underlying inflation was well below the 2% target, there was little need for heightened concern over upside deviations to prices. Policymakers therefore focused primarily on downside risks to economic activity and prices, with the Bank raising the policy rate gradually. However, Governor Ueda explained that upside price risks now warrant attention as well, effectively ushering in a phase requiring a symmetric monetary policy response to risks in both directions.

Given this stance, and with oil prices at elevated levels once again, I expect the BOJ will not only continue to raise rates but will also maintain the faster pace of tightening for some time. In this respect, both the policy statement and Governor Ueda's comments at the press conference can be characterized as hawkish.

The yen nevertheless weakened after the MPM. This may have reflected a modest retreat in expectations of further hikes after two of the nine Policy Board members opposed the increase and argued that rates should be held steady.

Governor Ueda's hawkish remarks prompted a brief rise in the yen, but the currency soon resumed its decline, possibly reflecting his cautious comments on back-to-back hikes and larger, 50bp increases.

The governor expressed concern that consecutive or 50bp hikes could trigger a substantial adjustment in financial conditions, and particularly in bank lending and asset markets. He also said that responding early to upside price risks could reduce the likelihood of inflation rising further and forcing the BOJ to carry out even larger rate hikes in the future.

Although Mr. Ueda maintained a flexible stance, noting that various outcomes were possible depending on price developments and that nothing was set in stone, financial markets ultimately appear to have concluded that consecutive or 50bp hikes were unlikely.

In my view, the upside risks to inflation and the risk of the Bank falling behind the curve have not increased sufficiently to warrant back-to-back or 50bp hikes. Market expectations of aggressive BOJ tightening seem to have gotten ahead of themselves, which may partly explain the subsequent decline in the yen.

Although financial markets had widely anticipated a 25bp hike at the September meeting, the yen weakened immediately after the announcement. As noted above, this reflected the fact that two of the nine Policy Board members opposed the hike and advocated leaving policy on hold.

This result was likely within the range of expectations of domestic market participants, but that may not have been the case among their overseas counterparts. The outcome appears to have come as something of a surprise in the forex market, where overseas participants have a substantial presence, and prompted a modest retreat in expectations of further rate hikes.

The two dissenters are so-called reflationists appointed by Prime Minister Takaichi, and their votes may have prompted market participants to view lingering political influence as an obstacle to further rate hikes. 

The Fed's rate hike at the September 16 FOMC meeting stands in sharp contrast to the BOJ decision. The FOMC's vote was unanimous—even governors appointed by President Trump, who wants the Fed to cut rates, supported the hike rather than accommodating his wishes.

By comparison, market participants may have concluded that monetary policy in Japan is more susceptible to political influence. Concerns over central bank independence may therefore have contributed to the decline in the yen.

However, strong pressure from the Trump administration appears to have constrained the ability of the Takaichi administration to stand in the way of BOJ rate hikes. Two hawkish Board members will leave office next July, but one occupies a seat traditionally filled by someone from the banking sector, making it more difficult for the administration to appoint a reflationist as his successor. And by next July, further rate hikes may have brought the tightening cycle close to completion.

In view of these considerations, I question the popular view that political influence will remain a major obstacle to BOJ rate hikes. 

I expect a rate hike in December 2026 or January 2027 will mark the end of the BOJ's accelerated tightening phase. The pace of rate increases is likely to moderate thereafter, with the next hike potentially coming in 2027 H2.

 I project the terminal rate—the policy rate's eventual endpoint—will be in the range of 1.75–2.0% and will be reached in 2027 H2 or 2028.

However, oil prices have recently resumed their advance, with WTI crude futures trading around $100 per barrel. If prices remain elevated, the BOJ will probably need more time to assess their impact on inflation and inflation expectations. In that case, the accelerated tightening phase could extend beyond year-end or early next year, potentially taking the policy rate up to 1.75%—close to the terminal rate—as early as 2027 H1.