Will Japan raise interest rates today? The market is concerned: will the camp be dovish or hawkish?

The Bank of Japan's interest rate hike is a done deal, but that's not the real suspense today.

The market widely expects the Bank of Japan to raise its policy rate from 1% to 1.25% on Friday, the highest level since 1995. This would be the first rate hike in three months and another step in the Bank of Japan's continued exit from its ultra-low interest rate policy. However, since the market has already fully priced in the rate hike, investors' attention has turned entirely to the post-meeting press conference— Governor Kazuo Ueda's remarks will determine whether the yen rises or falls next .

The current market yield curve already implies expectations of approximately four 25-basis-point rate hikes over the next year, equivalent to one hike at every other meeting until July 2027. This aggressive path sets an extremely high bar for Kazuo Ueda's statements: he must clearly confirm that the Bank of Japan is embarking on an unusually rapid tightening path to support further yen strength. If Ueda's statements disappoint the market, the USD/JPY exchange rate could recover all of its losses since September.

An interest rate hike is almost certain, but this is just the beginning.

Currently, the market widely expects the Bank of Japan to raise its policy rate by 25 basis points to 1.25% at its two-day policy meeting, which concludes on Friday. If this happens, it will be the highest policy rate in Japan since 1995 , and will also bring the rate into the lower end of the nominal neutral interest rate range (1.1% to 2.5%) estimated by the Bank of Japan.

Since ending its decade-long easing policy in 2024, the Bank of Japan has raised interest rates several times, roughly twice a year. This latest rate hike comes only three months after the last one (June), indicating a faster pace. Notably, according to Reuters, council member Toichiro Asada, who voted against the rate hike in June, may again object this time.

Even after this rate hike, the Bank of Japan's policy rate will still be far lower than that of other major central banks—the Federal Reserve's latest interest rate range is 3.75% to 4.00%, and the European Central Bank raised its key interest rate to 2.5% last week.

According to reports, the factors driving the Bank of Japan's latest interest rate hike are complex and are increasingly overlapping.

The war with Iran has triggered a surge in energy costs, leading to a sharp rise in wholesale inflation in Japan, which is expected to further impact consumer prices. Meanwhile, the continued weakness of the yen has pushed up import costs, exacerbating imported inflationary pressures. Critics argue that the Bank of Japan's overly slow pace of interest rate hikes is itself a contributing factor to the yen's weakness.

The Federal Reserve's actions have brought additional external pressure. The Fed raised interest rates this week and maintained market expectations for further rate hikes this year, meaning the US-Japan interest rate differential may widen further, putting downward pressure on the yen and pushing up Japanese inflation again through import costs. Takeshi Ishida, a strategist at Kansai Mirai Bank, stated...

"With the Federal Reserve raising interest rates and maintaining market expectations for further rate hikes, the Bank of Japan will face enormous pressure, and Ueda faces increased challenges at the press conference."

Furthermore, according to Reuters, U.S. Treasury Secretary Bessenter, during a meeting with Kazuo Ueda at the G20 finance ministers' meeting this month, explicitly expressed strong support for taking "decisive" monetary policy measures to address the yen's depreciation, a statement that further increased external pressure on the Bank of Japan.

The real suspense: What will Kazuo Ueda say today?

The interest rate hike itself is no longer a surprise to the market; Kazuo Ueda's forward-looking guidance is the biggest variable today.

According to Bloomberg, market expectations for the Bank of Japan's policy path have undergone a significant reassessment since the summer. The dollar fell to 152.89 against the yen earlier this month, reflecting strong market bets on the Bank of Japan accelerating its tightening. The current market-implied path is a 25 basis point rate hike every other meeting until July 2027.

A recent Bloomberg Pulse Survey (September 16-17, with 144 respondents) shows that nearly half of the respondents expect the peak policy rate in this rate hike cycle to fall between 1.5% and 1.75%, while about 17% expect the peak to reach 2%.

Analysts surveyed by Reuters expect the Bank of Japan to raise interest rates to 1.5% by the end of March next year, and further to 1.75% in the second quarter of 2027. Most analysts believe that the final interest rate will reach at least 1.75%.

However, several Bank of Japan officials, including Kazuo Ueda, have so far not specified the speed and magnitude of future interest rate hikes, emphasizing that this will largely depend on the inflation outlook and the impact of previous interest rate hikes on financial conditions.

According to reports, the threshold has now shifted from "convincing the market that a rate hike will occur in September" to "convincing them that a September rate hike will set off a faster pace." If Kazuo Ueda fails to achieve this, the USD/JPY exchange rate could further retrace its losses this month, especially given the backdrop of the Federal Reserve moving in the opposite direction.

Chidu Narayanan, head of Asia Pacific macro strategy at Wells Fargo, stated explicitly in a report, "We remain skeptical that the Bank of Japan can be more hawkish than the aggressive tightening path already priced in by the market. The threshold for the Bank of Japan to meet these expectations is high, and exceeding it is even more difficult."

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