Bank of Japan Set to Cross 0.5% Interest Rate Threshold

The Bank of Japan (BOJ) is gearing up to surpass the 0.5% interest rate mark, a level that has remained unchanged for nearly three decades. This potential increase hinges on the confidence of policymakers in Japan's ability to achieve a stable and sustainable inflation rate of 2%.

In a recent decision, the BOJ's board voted to adjust its target for the short-term policy rate upward from approximately 0.25% to around 0.5%. Should the central bank continue on this trajectory, it will approach what is termed the neutral interest rate--a rate that neither stimulates nor restricts economic growth. The BOJ anticipates reaching this neutral rate, estimated to be between 1% and 2.5%, by the conclusion of the fiscal year 2026.

A senior official from the BOJ has indicated that the target policy rate should be raised to a minimum of 1%. However, establishing the precise neutral rate poses significant challenges. BOJ Governor Kazuo Ueda has acknowledged that determining when to halt rate increases remains a considerable obstacle.

The last time the BOJ's policy rate hit 0.5% was approximately 18 years ago, following a series of rate hikes in July 2006 and February 2007, which came after the central bank ended its quantitative easing policy in March 2006. Subsequent to the global financial crisis of 2008, the BOJ reverted to quantitative easing, resulting in interest rates falling below zero.

Given the lack of empirical data regarding the Japanese economy's response to prolonged interest rate hikes, the BOJ is compelled to make decisions while vigilantly monitoring economic and price trends. Takahide Kiuchi, an executive economist at Nomura Research Institute, has suggested that Japan's neutral interest rate is just below 1%, a reflection of the country's modest potential growth rate.

Kiuchi emphasized the necessity for the BOJ to navigate policy adjustments with caution to mitigate any adverse impacts on the economy and inflation. He predicts that the central bank will likely raise the policy rate to 0.75% during the latter half of 2025, before potentially stopping further rate hikes.