Bank of Japan set to raise rates under pressure from inflation, US

The Bank of Japan (BOJ) is set to increase interest rates once more on September 18 to tackle inflation driven by soaring energy costs and to bolster the yen, under global scrutiny from the United States. Market eyes are on the U.S. Federal Reserve's decision on September 16, following the European Central Bank's recent hike. The BOJ, which convenes on September 17 and 18, is expected to raise its key rate by 0.25 percentage points to 1.25%, the highest level in over three decades.

Rising Middle East oil prices and a weak yen are contributing to inflationary pressures. The BOJ's decision to raise rates aligns with expectations, with former BOJ currency chief Takehiko Nakao and Capital Economics economists anticipating further rate hikes as the Middle East conflict persists. Capital Economics predicts headline inflation excluding fresh food and energy to rise to 2.5% by early 2027, with potential further increases if the government stops subsidizing electricity and gas.

The BOJ's move is also aimed at supporting the yen, which plummeted to its weakest level against the dollar in 40 years due to the interest rate gap between Japan and the Federal Reserve. A joint U.S.-Japan foreign exchange intervention in July offered temporary relief but has intensified pressure on the BOJ to accelerate rate hikes.

BOJ Governor Kazuo Ueda received backing from Bessent for Japan's market and monetary actions to address the yen's undervaluation. However, the BOJ's gradual shift towards normalizing interest rates, following years of accommodative policies, is a significant factor behind the weak yen.