Hawkish Surprise! Bank of Japan Unexpectedly Raises Interest Rates by 15 Basis Points, Reduces Quarterly Bond Purchases by ¥400 Billion

Zhitong Finance learned that the Bank of Japan unexpectedly raised interest rates on Wednesday, increasing the policy rate by 15 basis points to 0.15%-0.25%, while the market had expected it to remain unchanged. The central bank also announced plans to reduce bond purchases, highlighting its determination to normalize policy. The Bank of Japan announced that by the first quarter of 2026, it will reduce monthly bond purchases to 30 trillion yen, with a quarterly reduction of about 400 billion yen, cutting the scale of bond purchases more aggressively than the market generally expected to halve bond purchases within two years.

Bank of Japan Governor Haruhiko Kuroda's actions indicate his continued commitment to advancing monetary policy normalization. For years, the Bank of Japan has pursued an ultra-loose policy, including implementing the world's last negative interest rates before March of this year. Wednesday's actions may trigger speculation in the market that there may be another rate hike this year. Analysts believe that this rate decision is not dovish; the Bank of Japan has committed in writing that if the favorable conditions for economic activity and inflation prospects continue, it will further raise interest rates.

Analysts Toru Fujioka and Sumio Ito stated that the Bank of Japan's rate hike and the plan to reduce monthly bond purchases to around 30 trillion yen in the first quarter of 2026 indicate Governor Kuroda's willingness to continue the normalization process, fueling speculation of another rate hike this year.

However, the Bank of Japan also lowered its economic growth and inflation forecasts for this year. The Bank of Japan expects the median real GDP growth rate for the fiscal year 2024 to be 0.6% (down from the April forecast of 0.8%); the median core CPI excluding food for the fiscal year 2024 is expected to be 2.5% (down from the April forecast of 2.8%). The median real GDP growth rate and core CPI excluding food and energy for the fiscal year 2025 are unchanged from the April forecast at 1.0% and 1.9%, respectively. In addition, the Bank of Japan expects the median real GDP growth rate for the fiscal year 2026 to be 1.0% and the median core CPI for the fiscal year 2026 to be 1.9%.

Most economists had expected the Bank of Japan to delay the rate hike in July, believing that the Bank of Japan would prefer to wait until there is confidence in the recovery of private consumption before raising rates. Personal spending in Japan has slowed for four consecutive quarters, as wage growth has not kept pace with inflation for over two years. Weak consumption is seen as a reason for the imbalanced performance of the Japanese economy. The Japanese economy has contracted twice in the past three quarters. Economists expect real wages to turn positive around August, when the record 3.56% wage increase agreed upon by companies and unions in March is expected to mainly reflect on paychecks.

The Bank of Japan currently purchases government bonds at a monthly scale of about 6 trillion yen. The Bank of Japan plans to gradually reduce its purchases of Japanese government bonds starting from July this year, at a pace of approximately 400 billion yen per quarter: July 2024 (5.7 trillion yen), August to September 2024 (5.3 trillion yen), October to December 2024 (4.9 trillion yen), January to March 2025 (4.5 trillion yen), April to June 2025 (4.1 trillion yen), July to September 2025 (3.7 trillion yen), October to December 2025 (3.3 trillion yen), January to March 2026 (2.9 trillion yen).

By cutting back on the bond purchase program, the Bank of Japan is embarking on a path of quantitative tightening. As of March this year, the Bank of Japan has accumulated 576 trillion yen worth of Japanese government bonds through the large-scale "quantitative easing" program launched in 2013, accounting for 53% of the total outstanding government debt of Japan, with an even larger share in the market for 10-year and shorter-term bonds.

A survey conducted by QUICK, a Nikkei-owned institution, on 181 bond investors from July 23 to 25, showed that only 26% of market participants expect a rate hike, with most investors expecting the rate hike to take place in September or October. This aggressive move indicates the Bank of Japan's increasing confidence in the domestic economic recovery, while also expressing concerns about a significant depreciation of the yen. The Bank of Japan also mentioned that the impact of the foreign exchange market on prices is more significant than before.

Hours before the Federal Reserve's meeting, the hawkish stance of the Bank of Japan may signal a turning point for the struggling yen, as traders expect the interest rate differential between the US and Japan to narrow. Any hints from the Federal Reserve of a possible rate cut in September will support this view.

The Bank of Japan's gradual approach contrasts with the rapid tightening by the Federal Reserve in 2022, which raised policy rates by 5.25 percentage points between 2022 and 2023. The significant interest rate differential has led to funds flowing from Japan to the US, causing the yen to continue to depreciate; the yen against the US dollar exchange rate approached 162 this month, hitting a 37-year low, and has fallen by nearly 30% since early 2022. Following the news release, the yen exchange rate experienced sharp short-term volatility and rose rapidly, with the US dollar against the yen currently falling below 153, having briefly dropped below the 152 level earlier.

It is believed that the Japanese monetary authorities intervened in the foreign exchange market earlier this month by buying yen. On Wednesday evening, the Japanese Ministry of Finance will release a monthly report on yen intervention, allowing investors to verify the country's market behavior