Why did the Bank of Japan keep rates steady amid inflation?

The Bank of Japan’s latest rate decision surprised some analysts despite intense speculation about monetary tightening. On Thursday, the BOJ voted 7-2 to keep rates steady at 0.5 percent, extending a streak of six consecutive holds even as inflation continues to run above the central bank’s 2 percent target.

The surprise sent the yen tumbling to its lowest level in eight months, crossing 153 per US dollar as investors weighed the central bank’s rationale.

Japan’s leaders now face renewed scrutiny over their approach to inflation, currency stability, and political priorities after a pivotal policy meeting.

What guided the BOJ’s rate decision?

The BOJ’s decision hinged on a careful assessment of economic indicators, particularly core inflation, which hit 2.9 percent in September.

This figure is substantially above the central bank’s official target. Still, BOJ Governor Kazuo Ueda and the majority of the policy board determined that domestic wage growth and underlying demand were not yet robust enough to justify higher borrowing costs.

Members cited global market uncertainty and Japan’s fragile recovery from the pandemic among the reasons for caution.

Two board members, Naoki Tamura and Hajime Takata, disagreed with the consensus. They argued that the price stability target had been mainly achieved and proposed a rate hike to 0.75 percent, the first such level in over three decades.

Both cited underlying price pressures and diminishing deflationary risks as grounds to move policy closer to neutral, reflecting deepening divisions within the board over how best to address inflation risks.

Did you know?
The Japanese yen is consistently the third most traded currency in the world's foreign exchange market, following the US Dollar (USD) and the Euro (EUR).

How did politics influence the outcome?

Politics loomed large in the lead-up to the announcement, as the BOJ convened for its first meeting since Sanae Takaichi became prime minister. Takaichi is known for her vocal support of loose monetary policy and aggressive fiscal spending.

Her administration’s views are likely to have buoyed the dovish camp at the BOJ, reinforcing the argument that any tightening could threaten Japan’s fragile economic recovery.

Political pressure from within the government intersected with opinions from abroad. US Treasury Secretary Scott Bessent publicly urged Tokyo to allow greater policy flexibility to avoid excessive currency volatility.

This transpacific push likely influenced central bank messaging, as did Japan’s need to keep debt-servicing costs low amid massive government borrowing.

Why did the yen weaken so sharply?

The yen’s rapid decline following the decision stemmed from shifting market expectations rather than unexpected policy moves. Traders and investors had positioned for a possibility, however slim, of an imminent rate hike given persistent inflation, the new prime minister’s mandate, and global central bank activity.

When the 0.5 percent rate was reaffirmed, those expectations were dashed, and the yen slid beyond 153 per dollar in minutes.

The context also mattered: the US Federal Reserve had just completed its second rate cut of the year, widening the gap between the dollar and the yen.

With Japan holding and the US easing less aggressively than feared, speculators rushed out of the yen, anticipating further declines unless Tokyo changes course or intervenes directly in the currency markets.

What are the risks of staying the course?

Japan’s path carries clear risks. While maintaining loose policy shields domestic businesses and the government from higher borrowing costs, it undermines the yen’s value and, by extension, Japanese households’ purchasing power.

Imported goods and energy prices have risen, and consumer sentiment remains weighed down by the currency's persistent weakness.

There is also an intensifying risk that FX volatility could spiral out of control or prompt competitive devaluations in the region.

Some analysts worry that if the BOJ waits too long, it may have to act more aggressively later, which could cause sharper market and broader economic shocks.

Dissenting voices within the bank and industry are increasingly vocal about the potential dangers of delay, especially as inflation proves persistent.

What comes next for Japan’s monetary policy?

Looking ahead, the BOJ must balance wage growth, inflation pressures, and yen stability. Market participants will watch upcoming wage data and global developments for cues.

Governor Ueda signaled a readiness to act if inflation expectations become unanchored, but the threshold for policy tightening remains high given economic and political sensitivities.

All eyes are now on the next round of data and meetings, while global trends shape Tokyo’s choices.

For now, the prospect of a rate hike appears distant, but shifting sentiment or external pressures could prompt the BOJ to rethink its stance sooner than markets currently expect.

In the coming months, Japan faces a delicate equilibrium. Any decision to shift course could send powerful signals to financial markets worldwide.

Policymakers and business leaders will be watching closely as they navigate the pressure points between inflation, economic growth, and currency volatility.