Bank of Japan deputy chief calls for timely rate hike to address inflation risk

Bank of Japan Deputy Governor Ryozo Himino just told markets what they’d been expecting to hear, but with enough urgency to move the needle. Speaking in Saitama on August 27, Himino stressed the need for timely interest rate increases to prevent inflation from overshooting the BOJ’s 2% target, a message that sent traders scrambling to reprice the odds of a September hike.

Overnight index swaps now reflect an 85-90% probability that the BOJ will raise rates at its September 17-18 policy meeting. The current policy rate sits at 1%, after the central bank bumped it up from 0.75% in June. If September delivers another increase, it would mark yet another step in Japan’s slow-motion exit from decades of ultra-loose monetary policy.

The inflation backdrop

Himino’s comments didn’t arrive in a vacuum. Japan’s core Consumer Price Index for July climbed 1.8% year-over-year, the fastest pace since January. The yen remains stubbornly weak, making imports more expensive. Energy prices have been climbing thanks to geopolitical instability in the Middle East.

Himino didn’t go so far as to explicitly endorse a September hike. Instead, he called for “robust discussions at each policy meeting” on the appropriate pace of tightening.

The deputy governor’s framing was notable for its emphasis on overshoot risk. For a central bank that spent the better part of two decades trying desperately to generate inflation, worrying about too much of it represents a philosophical U-turn of considerable proportions.

Japan’s long road from zero

The BOJ maintained negative interest rates from 2016 until early 2024, when it finally ended that experiment. The journey from negative territory to a 1% policy rate has been gradual by design, with each step accompanied by careful communication meant to avoid spooking markets.

Some economists are now forecasting a potential terminal rate of around 1.75%.

What this means for markets

Bond markets are another obvious pressure point. Japanese government bonds have been adjusting to the new rate environment, and yields would likely push higher if the BOJ delivers in September. Given that Japanese investors are among the world’s largest holders of foreign bonds, particularly US Treasuries, any meaningful shift in domestic yields could trigger repatriation flows that echo across global fixed income markets.

Carry trades involving the yen, which blew up spectacularly in mid-2024, remain sensitive to shifts in rate differentials.

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