Japan’s First Rate Hike in 11 Months: What It Means for Markets

TLDR

• Bank of Japan expected to raise interest rates by 0.25 percentage points to 0.75% on Friday, reaching a 30-year high
• The rate hike could impact U.S. markets by unwinding the carry trade where investors borrow cheap yen to buy higher-yielding U.S. Treasuries
• Japanese companies expect continued wage growth in 2026, supporting the central bank’s case for raising rates
• The spread between U.S. and Japanese 10-year bond yields has narrowed from 3.3 percentage points to 2.2 points over the past year
• Political pressure has mounted on the BOJ to raise rates as yen weakness drives up import prices and living costs

The Bank of Japan is preparing to increase interest rates for the first time in 11 months. Markets are pricing in an 82% probability that the central bank will raise its policy rate by a quarter percentage point to 0.75% when its two-day meeting concludes on Friday.

The expected move would push Japan’s interest rates to their highest level in three decades. Governor Kazuo Ueda has signaled the hike is coming after keeping rates at 0.5% since January.

The BOJ paused rate increases earlier this year due to uncertainty around U.S. tariffs and the need for clearer economic data. Inflation has remained persistent in Japan between August and October, giving policymakers more reason to act.

A key factor supporting the rate increase is wage growth. A BOJ survey released Monday showed Japanese companies plan to continue raising salaries in 2026, matching this year’s pay increases.

The central bank wants to ensure wage growth translates into sustainable inflation. Governor Ueda has stated he is monitoring early indicators of companies’ salary plans for next year, with firm data expected in March.

Impact on U.S. Markets

The rate hike could create ripples for American investors and borrowers. Higher Japanese interest rates may unwind the carry trade, where investors borrow yen at low costs to invest in U.S. Treasuries and other higher-yielding assets.

Japanese investors have poured hundreds of billions of dollars into U.S. Treasuries in recent years. If they redirect their money elsewhere, demand for U.S. government debt could decline at a time when concerns about the federal deficit are already mounting.

The yield spread between 10-year U.S. and Japanese bonds has already shrunk. The difference now stands at 2.2 percentage points, down from 3.3 points one year ago, making the carry trade less attractive.

Some analysts worry this shift could increase borrowing costs for both the U.S. government and ordinary Americans. The carry trade has effectively helped finance American spending and investment.

Political Pressure Mounts

Prime Minister Sanae Takaichi’s government has backed the rate increase despite earlier concerns about tightening monetary policy. The yen’s recent weakness has pushed up import prices, creating political pressure to act.

Rising living costs have become a major issue for the Takaichi administration. Food prices and other essentials have climbed, squeezing household budgets and making rate action more urgent.

The yen has gained 1.5% against the dollar in 2025, while Japan’s Nikkei 225 stock index has risen 24% this year. That performance has outpaced the S&P 500, which has declined 0.24% over the same period.

Economists expect future rate increases to proceed slowly, with hikes potentially coming every six months. The BOJ will monitor how lending activity and the broader economy respond to interest rates Japan hasn’t seen in decades.

The central bank believes Japan’s neutral interest rate falls somewhere between 1.0% and 2.5%. Governor Ueda has said the BOJ will provide a more precise estimate when more data becomes available.

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