BOJ Prepares for Next Rate Hike, Eyes Terminal Rate Uncertainty

The Bank of Japan (BOJ) is expected to raise interest rates next week by 25 basis points, bringing its policy rate to levels unseen in 31 years. According to four sources familiar with the BOJ's thinking, a hike to 1.25 per cent would signal faster future tightening if price pressures heighten the risk of an inflation overshoot.

The economy is on course for a moderate recovery, and price pressure is building. The BOJ expects financial conditions to remain loose even if it were to take interest rates to 1.25 per cent, said the sources, who spoke on condition of anonymity as they were not authorized to speak publicly.

While the yen's recent rebound could ease pressure on prices by moderating increases in import costs, the currency's past declines and a renewed surge in fuel prices will keep the BOJ on guard over inflation risks. 'With underlying inflation so close to 2 per cent, the BOJ needs to be extra mindful of upside price risks,' said one of the sources.

Analysts polled by Reuters expect the BOJ to hike rates to 1.25 per cent at the September 17-18 meeting, 1.5 per cent by end-March next year, and then to 1.75 per cent in the second quarter of 2027. Most saw the terminal rate as being at least 1.75 per cent.