On Tuesday, a rate hike by the Bank of Japan is "a foregone conclusion," and the 1% interest rate era is expected to return!

On Tuesday, the Bank of Japan will face its most closely watched interest rate decision in nearly thirty years. The market almost unanimously expects the central bank to raise rates by 25 basis points to 1%, marking Japan's return to the 1% interest rate era for the first time since 1995.

But according to Barclays and Nomura, what determines the fate of the yen is not the rate hike itself, but whether the central bank is willing to signal a more aggressive tightening stance. The two institutions pointed out that the market has already fully priced in the June rate hike expectation; if the central bank only delivers a "no surprise" 25 basis point hike, the yen may not strengthen; only by convincing the market that more rate hikes will follow can the multi-year depreciation trend truly be reversed.

Looking ahead, Barclays expects this tightening cycle is far from over, with further 25 basis point hikes in October this year and April 2027, ultimately raising the policy rate to 1.5%. Nomura, meanwhile, maintains that the core focus of this meeting is whether the central bank signals a "speeding up of rate hikes," including whether any committee members advocate a one-off 50 basis point hike, and whether the policy statement continues to emphasize that real interest rates are "significantly low."

Currently, USD/JPY remains around 160, and Japanese government warnings about currency intervention are continuously escalating. For the Bank of Japan, this meeting is not only about interest rates, but also about whether the market can once again believe in its commitment to controlling inflation and stabilizing the exchange rate.

Bank of Japan refocuses on inflation, rate hikes may be far from over

Over the past few months, the Bank of Japan has constantly wavered between inflation risks and growth concerns. Escalation in the Middle East, rising oil prices, and global economic uncertainty once made the market doubt whether the Bank of Japan would delay rate hikes. However, Barclays believes that a series of recent data has shifted the central bank’s attention back to inflation.

The most critical variable comes from structural changes in Japanese enterprises' pricing power. In the past, Japanese companies used to absorb rising costs by squeezing profits, making it difficult for input inflation to evolve into sustained price increases. But in recent years, labor shortages, rising wages, and changes in consumption habits are gradually breaking this old pattern.

Companies’ willingness and ability to pass on costs have significantly increased. Barclays' research shows that, compared to before 2021, Japanese companies are now more able to pass rising costs onto consumers. The transmission effect of import prices to producer price index (PPI) and consumer price index (CPI) has significantly improved, meaning inflation pressures from oil price rises and the yen’s depreciation will persist longer.

This has made the Bank of Japan worry about "falling behind the curve." Data show that Japanese import prices in yen rose 25.5% year-on-year in May, and the producer price index rose 6.3% year-on-year. According to Barclays, if the central bank continues to maintain a relatively loose policy stance, it may be forced to adopt more aggressive tightening measures in the future.

For this reason, Barclays expects the Bank of Japan will not stop at the 1% interest rate level. The bank believes the central bank will continue to raise rates over the next year, ultimately increasing the terminal rate to 1.5% to cope with increasingly stubborn inflation pressures.

What determines the fate of the yen is the “degree of hawkishness”

The most watched aspect of this meeting is not the rate decision, but the subsequent policy communication. Both Barclays and Nomura cite the following three points as the core observation indicators for this meeting:

First is the adjustment of real interest rate wording. The Bank of Japan’s current guidance describes the real interest rate as “at a significantly low level.” Nomura believes that if the central bank keeps the wording “at a significantly low level,” it suggests there is still room for several future rate hikes; if changed to “still at a low level,” the market will interpret this as dovish. Barclays expects that, given current expectations for USD appreciation and yen depreciation pressures, the central bank may keep the original wording unchanged.

Second is the policy committee voting distribution. Since the April meeting, including Junko Nakagawa, who previously held a relatively neutral stance, at least four committee members (Nakagawa, Takata, Tamura, Misumi) have openly leaned towards rate hikes. Nomura points out that if hawkish committee members Takata or Tamura vote for a 50 basis point hike, it will send a strong signal to the market, implying the pace of rate hikes may accelerate; on the other hand, if newly appointed member Asada votes against a rate hike, it could increase market concern about political interference with monetary policy.

Third is the tone of Deputy Governor Uchida’s press conference. Barclays believes Uchida may maintain a hawkish stance on inflation risks, but unless he clearly suggests speeding up tightening, it will be hard to prevent further yen weakness. Nomura notes that, given ongoing Middle East uncertainties, the central bank is unlikely to make a clear commitment about the timing of the next rate hike, and hawkish statements will likely be limited to warnings about inflation risks.

Yen "defense battle" enters a critical moment

Historical experience shows that a single 25 basis point rate hike is unlikely to fundamentally reverse the yen’s trend. The core variable currently affecting the USD/JPY exchange rate remains the U.S.-Japan yield gap—against the backdrop of persistently high U.S. 10-year Treasury yields, even if Japan’s rate is raised to 1%, the gap with the U.S. remains vast.

Therefore, if the Bank of Japan fails to convince the market of further rate hikes, capital will still tend to flow into U.S. assets. And once USD/JPY breaks through the 160 level and continues to rise, the likelihood of Japanese government intervention in the currency market will increase sharply.

Recently, Japan’s Minister of Finance has unequivocally stated that authorities are “ready to take decisive action at any time.” The market generally expects that, as the latest central bank meeting concludes, currency intervention risk will once again become the main focus.

Risk Warning and DisclaimerThe market carries risks; investment requires caution. This article does not constitute personal investment advice and does not consider the specific investment goals, financial conditions, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their particular situation. Investing based on this is at your own risk.