The Bank of Japan (BOJ) is expected to maintain its commitment to raising interest rates at its upcoming policy meeting on December 18-19, although the pace of further hikes will depend on economic responses to prior increases, according to sources familiar with the central bank’s thinking.

Markets have largely priced in a potential increase from 0.5% to 0.75%, following hints from Governor Kazuo Ueda, who suggested the BOJ is prepared to continue tightening monetary policy. While this move would mark a historic step, bringing policy rates close to the bottom of the central bank’s estimated neutral range, sources emphasize that future decisions will be guided primarily by economic performance rather than fixed targets.

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BOJ Approach to Neutral Rates

Although the BOJ may internally update its estimate of the neutral interest rate—the level at which policy neither stimulates nor slows growth—it will not rely on this estimate as a public communication tool.

Sources indicated that the central bank will instead focus on the economic impact of each rate hike, including effects on:

• Bank lending conditions
• Corporate financing
• Broader economic activity

“Japan’s real interest rates are very low, allowing the BOJ to continue raising rates in several stages,” said one source, reflecting a consensus among insiders.

With inflation above the 2% target for more than three years, Japan’s real borrowing costs remain deeply negative, supporting further policy tightening while maintaining accommodative financial conditions.

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Market Implications

A rise to 0.75% would mark the highest BOJ policy rate in three decades, although still modest compared to many other major economies. The move signals that the BOJ is determined to balance monetary tightening with ongoing support for economic growth, rather than using neutral rate estimates as a strict benchmark.

Analysts highlight that the BOJ’s approach involves incremental rate hikes, with close monitoring of economic reactions to ensure that monetary policy remains supportive without overstimulating or cooling the economy too sharply.

BOJ board member Asahi Noguchi emphasized the difficulty in precisely estimating the neutral rate, noting it is “almost impossible” to gauge accurately. Former BOJ economist Seisaku Kameda added that the central bank will likely exercise caution as rates approach neutral levels but will continue communicating that monetary conditions remain accommodative even after incremental hikes.

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Outlook

Investors and policymakers will closely watch the BOJ’s upcoming meeting for signals on the future trajectory of interest rates, as well as guidance on how the central bank intends to navigate rising inflation and maintain financial stability. The move is expected to have implications for:

• Yen exchange rates
• Japanese stock and bond markets
• Global investor sentiment toward Japan’s economic growth