BoJ set to continue raising rates in 2025

At its meeting on 24 January, the Bank of Japan (BoJ) Policy Board raised its policy interest rate by 25 basis points to 0.5%. In this Macro Flash Note, Economist Sam Jochim explains the reasons behind the decision and discusses the policy outlook for 2025.

At its December 2024 meeting, the BoJ left monetary policy unchanged, citing uncertainties regarding the outlook for wages, prices and overseas economies. The Bank’s decision to raise interest rates in January 2025 therefore reflected a greater degree of certainty regarding the outlook for these factors.

Regarding wages, Governor Ueda gave an interview in the week preceding the January Policy Board meeting in which he placed emphasis on the positive discussions held with the BoJ’s regional branch managers. A document published alongside the BoJ’s January decision noted that firms have “expressed the view that they will continue to raise wages steadily, following the solid wage increases last year”.¹

Last year saw the largest agreed wage increases in 33 years in Japan during the Shunto, a key factor in the BoJ exiting its negative interest rate policy in March.² A similar outcome has been sought by labour union representatives this year and the BoJ has evidently gained confidence it will be achieved (see Chart 1).

Chart 1. Shunto results (wage increase, %)

The BoJ has also become more confident in the inflation outlook in Japan. In its post-meeting decision document, the Bank stated that “with wages continuing to rise, underlying CPI inflation has been increasing gradually toward 2 percent”.³ The Policy Board expects inflation to average 2.7% in fiscal year (FY) 2024 before declining to 2.4% in FY 2025.⁴ Both forecasts are above those made in October 2024 (see Chart 2).

Chart 2. Japanese core consumer price index (CPI) inflation and BoJ forecasts (% change, year-on-year)

The remaining factor that the BoJ highlighted in its December 2024 meeting regarded policy abroad. The Bank emphasised significant uncertainty about US economic policies and how they could impact the global economy. In its view, the risks to prices stemming from this uncertainty are skewed to the upside for FY 2024 and 2025, helping explain why the Policy Board deemed it appropriate to raise interest rates in January.

In terms of the outlook for monetary policy in Japan in 2025, it is notable that January’s policy decision represented the first interest rate increase since July 2024, thereby maintaining a cautious approach to policymaking. The BoJ is reticent to shock financial markets after doing so in July and is therefore likely to give guidance on policy decisions ahead of meetings.

The BoJ has placed emphasis on the fact that real interest rates remain “significantly negative” and that financial conditions are therefore accommodative. If economic conditions materialise broadly in line with the BoJ’s expectations, it is reasonable to expect more policy rate increases in 2025.

BoJ staff have estimated a range for the neutral real policy rate of between -1% and 0.5%.⁵ Assuming inflation is 2% gives a nominal policy rate between 1% and 2.5%. While such a range is large, the lower bound provides a good guide as to where rates could reach this year. Markets expect one more 25 basis point rate hike in 2025 and while this is not an unrealistic scenario, there are risks that the BoJ is more hawkish than markets currently expect. In summary, the BoJ raised its policy rate at its January meeting due to greater certainty regarding the outlook for wages and prices and its assessment that risks to prices stemming from policy uncertainty abroad are skewed to the upside. While the pace of policy normalisation will remain gradual, further interest rate increases should be expected in 2025 and it is possible the BoJ has a more hawkish policy-bias than markets are currently expecting.

¹ https://www.boj.or.jp/en/mopo/mpmdeci/mpr_2025/k250124b.pdf

² Shunto is a Japanese term which refers to the annual Spring wage negotiations between labour unions and many large employers in Japan.

³ The Bank of Japan has a mandate to achieve price stability and has set the price stability target at 2% in terms of the year-on-year change in the consumer price index.

⁴ https://www.boj.or.jp/en/mopo/outlook/gor2501a.pdf

⁵ https://www.boj.or.jp/en/research/wps_rev/wps_2024/data/wp24e12.pdf

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