Policy normalization in Japan: how high will the BoJ go?
The Bank of Japan has continued to raise interest rates in an effort to "normalize" monetary policy, presenting potential opportunities for discerning investors.
On January 24, 2025, the Bank of Japan (BoJ) raised its key policy interest rate by 25 basis points to 0.50%—the highest it’s been in 17 years, signaling the central bank’s mounting confidence that rising wages should keep Japanese inflation at or around its 2% target. This latest step marks the BoJ’s third rate hike in a monetary policy normalization cycle that began nearly a year ago, leaving many policy watchers and investors now wondering: Just how high might the BoJ take rates?
BoJ policy normalization: full speed ahead?
The January rate hike is unlikely to be the BoJ’s last move higher, in our view. Indeed, ongoing policy normalization in Japan remains one of our team’s strongest-conviction macroeconomic themes, as the central bank attempts to bring its benchmark rate up to a neutral threshold after years of ultra-accommodative monetary policy. Our current base case calls for one more BoJ rate hike in 2025 and another two in 2026, which would imply a terminal rate of at least 1.25%. Market pricing finally reflects our 2025 rate outlook for Japan, with an additional hike now priced into the latter half of the year.
The anticipation of several further rate increases over the next two years makes the BoJ an outlier among the world’s developed-market central banks, most of which appear to be in some stage of policy easing at this juncture. (See Five macroeconomic themes for 2025: a global economy in transition to learn more.) The BoJ similarly bucked the prevailing trend in 2022 when it opted not to raise interest rates, even as other major central banks were doing so in an effort to rein in stubborn inflation.
The anticipation of several further rate increases over the next two years makes the BoJ an outlier among the world’s developed-market central banks, most of which appear to be in some stage of policy easing at this juncture.
A favorable economic backdrop for rate hikes
The main reason we believe the BoJ can and will continue to gradually raise rates in the period ahead is simply that domestic economic conditions have improved recently, enabling Japan to finally break out of its multidecade deflationary spiral:
- Japanese wage growth is approaching 32-year highs, with the country’s labor unions apparently prepared to seek wage gains of 5% in the upcoming spring wage negotiations (Japan’s so-called “shunto”).
- Notably, the “virtuous wage/price cycle” described by the BoJ appears to be in play these days, with headline and core inflation readings both expected to remain at or above the bank’s targets through 2025 and 2026.
- In fact, just this past month, the BoJ upgraded its 2025 CPI forecasts to 2.4% (headline inflation) and 2.1% (core inflation), respectively.
- Leading economic activity indicators of late, such as Japan’s Tankan survey and its Purchasing Managers' Index (PMI), suggest a healthy domestic demand impulse that should put upward pressure on prices for the foreseeable future.
Japan’s 2025 spring wage negotiations may support continued wage growth
Other factors that may shape BoJ monetary policy
Along with Japan’s favorable domestic macro backdrop, other factors might also bolster the BoJ’s more hawkish policy stance going forward.
For one thing, further rate hikes would likely support the still-weak Japanese currency (the yen), which today sits near 30-year lows and is helping to push consumer prices up via more expensive imports from abroad. Also, the BoJ conducted an empirical study showing that Japan’s extended era of rock-bottom rates didn’t produce all of the desired results, underscoring the BoJ’s present need to normalize monetary policy. While there were modest positive impacts on Japan’s economy, there were also negative impacts on the Japanese bond market’s functioning and on many financial institutions’ interest margins.
From a more tactical perspective, the BoJ’s rate actions may be influenced to some degree by U.S. monetary policy developments and global capital markets behavior. A deep rate-cutting cycle by the U.S. Federal Reserve (Fed) would have created a headwind for BoJ rate hikes, but the Fed’s relatively less dovish position in recent months should make it easier for the BoJ to keep lifting its policy rate. The potential for market volatility in response to global trade uncertainty could also pose a risk to BoJ rate increases, given the central bank’s cautious and risk-averse tendencies. However, we perceive Japan as being less vulnerable to U.S. tariffs than China, Europe, and Canada.
Investment implications: the long and short of it
- Long the Japanese yen: Given our high conviction in more BoJ rate hikes to come, we see the yen gaining strength versus other global currencies over short-, medium-, and long-term time horizons. From a fundamentals standpoint, for example, we believe the yen is undervalued at today’s levels and may offer investors an appealing risk/reward profile.
- Short Japanese government bonds: While Japanese government bond yields have already experienced a sustained rise, we think they may have room to climb even higher this year and next, particularly if economists and analysts boost their BoJ policy rate estimates to match ours (i.e., at least 1.25% by the end of 2026).
- Long unhedged Japanese equities: Our team maintains a positive long-term strategic outlook on Japanese equities amid continued BoJ progress toward normalized monetary policy, encouraging corporate reforms in Japan, and surging Japanese corporate profits. At this time, the prospect of yen appreciation leads us to generally prefer unhedged equity allocations over currency-hedged ones.
Given our high conviction in more BoJ rate hikes to come, we see the yen gaining strength versus other global currencies over short-, medium-, and long-term time horizons.
Important disclosures
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person.
All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients and prospects should seek professional advice for their particular situation. Neither Manulife Investment Management, nor any of its affiliates or representatives (collectively “Manulife Investment Management”) is providing tax, investment or legal advice.
Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than a century of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.
This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Manulife Investment Management shall not assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment approach, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation doesn’t guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
This material has not been reviewed by, and is not registered with, any securities or other regulatory authority, and may, where appropriate, be distributed by Manulife Investment Management and its subsidiaries and affiliates, which includes the John Hancock Investment Management brand.
Copyright 2025 by Manulife Investment Management. Manulife Wealth and/or Manulife Private Wealth are using with permission. The statements and opinions expressed in this article are those of the author. Manulife Wealth and/ or Manulife Private Wealth cannot guarantee the accuracy or completeness of any statements or data.
Australia: Manulife Investment Management Timberland and Agriculture (Australasia) Pty Ltd, Manulife Investment Management (Hong Kong) Limited. Brazil: Hancock Asset Management Brasil Ltda. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. Mainland China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Investment Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad 200801033087 (834424-U) Philippines: Manulife Investment Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) South Korea: Manulife Investment Management (Hong Kong) Limited. Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. United Kingdom: Manulife Investment Management (Europe) Ltd. which is authorised and regulated by the Financial Conduct Authority United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment Management Private Markets (US) LLC and Manulife Investment Management Timberland and Agriculture Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited.
Manulife, Manulife Investment Management, Stylized M Design, Manulife Investment Management & Stylized M Design, Manulife Wealth & Stylized M Design and Manulife Private Wealth & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.
4208174
Erica Camilleri, CFA,
Senior Global Macro Analyst, Multi-Asset Solutions Team
Manulife Investment Management
Read bio