The Bank of Japan maintains interest rates as scheduled and raises inflation forecasts for the fiscal year 2026.

The Bank of Japan maintains the benchmark interest rate unchanged and has raised inflation expectations to closely monitor the impact of last month's rate hike and await the early election results that could affect the fiscal spending plan. The Bank of Japan issued a statement on Friday stating that it will maintain the policy rate unchanged at 0.75%, consistent with the predictions of all surveyed economists. This means that borrowing costs are at their highest level in thirty years. Board member Takada Satoshi voted in favor of another rate hike, while other board members supported keeping the rate unchanged. The central bank raised four of the six inflation forecasts in its latest quarterly outlook and reiterated its intention to raise borrowing costs if its outlook becomes reality. The central bank currently expects the core inflation rate, excluding fresh food, to average 2.2% for the fiscal year starting in April, higher than the previous expectation of 2%. A report released earlier in the day showed that the year-on-year growth rate of core CPI in December, excluding fresh food prices, slowed to 2.4% due to the impact of government subsidies, both past and present. The report also noted that inflation has averaged above the Bank of Japan's 2% target level in the past four calendar years. The weakening yen and the fiscal policy of Naoto Takamatsu are key factors in the rate hike. The outlook suggests that the committee led by Bank of Japan Governor Ueda Kazuo, who raised the policy rate to its highest level since 1995 last month, is planning another rate hike. When considering the timing of the next steps, the central bank needs to balance the impact of the December rate hike on prices and the economy, the inflationary effects of the continued weak yen, and the election results. Shortly after the Bank of Japan announced the news, the yen weakened slightly, trading near 158.60 yen per dollar. Earlier this month, the yen fell to a new 18-month low of 159.45 with reports of Naoto Takamatsu calling for early elections. If Naoto Takamatsu wins the elections and consolidates her majority in parliament, she will have more room to implement expansionary fiscal policies. This could further weaken the yen and increase long-term bond yields. The weakening yen is one of the factors that could lead to an early rate hike. On Friday, the yen was not far from the 160 level against the dollar. The level of 160 is considered a rough critical point for the Bank of Japan's multiple rounds of interventions by 2024. As the Bank of Japan tightens monetary policy, Japanese government bond yields continue to rise, reaching new highs in decades over the past month, leading to capital outflows and weakening the yen. At the same time, the Bank of Japan stated that real interest rates are still negative, and fiscal concerns are increasing. Naoto Takamatsu plans to set a record budget of $78.3 billion for the fiscal year starting on April 1st, in addition to a $135 billion stimulus plan introduced last year to help families cope with rising living costs. Just a few days ago, Japanese Prime Minister Naoto Takamatsu promised to suspend consumption tax on food as part of her election manifesto on February 8th, causing turmoil in financial markets. Earlier this week, Naoto Takamatsu promised to reduce the consumption tax on food and non-alcoholic beverages to zero for a period of two years if she and her Liberal Democratic Party win the national election. This measure aims to alleviate the pressure on households affected by inflation, especially rising food prices, and is expected to save 5 trillion yen (about $32 billion). Despite the Bank of Japan's desire to cultivate stable inflation after decades of price weakness and deflation, cost of living deflation has become a major source of dissatisfaction among voters. Recent polls show that Naoto Takamatsu still enjoys high support rates by historical standards, with over 60% of respondents saying that lowering prices is her top priority in office. Naoto Takamatsu's tax proposal comes after the passage of a $1.77 trillion economic stimulus package through parliament last month by the prime minister. The plan includes provisions to reduce utility and gasoline prices. Despite these measures, the Bank of Japan has raised price expectations in its latest quarterly outlook report, as these measures are expected to increase potential inflation over the long term. Naoto Takamatsu promised to strengthen her expansionary fiscal policy and suspend the 8% sales tax on food, raising concerns about issuing more debt and causing bond yields to soar, which could harm the economy. Rising yields have once again raised concerns about the Bank of Japan's quantitative tightening plan. According to the plan, the Bank of Japan has been gradually reducing the size of its balance sheet by slowing down its bond purchases, gradually exiting its massive stimulus policy. The Bank of Japan has been gradually reducing bond purchases in a planned manner since 2024. However, the Bank of Japan stated that it may pause the reduction plan or conduct emergency bond purchases to deal with extreme market pressures. Some analysts speculate that the Bank of Japan may soon use these tools. However, the Bank of Japan has set a high threshold for using these measures because increasing bond purchases goes against its efforts to gradually phase out stimulus measures implemented to combat deflation for many years. Attention to statements by Governor Ueda Kazuo Bank of Japan Governor Ueda Kazuo will elaborate on the reasons for this decision, possible interest rate trends, and inflation prospects at the press conference, which usually starts at 14:30 Beijing time. His statements may affect the yen exchange rate, and any comments on the recent surge in long-term yields will be closely watched. He must be cautious in describing the urgency of the next rate hike. If his remarks are perceived as dovish, the yen may face new selling pressure. Traders will pay close attention to whether the situation evolves similarly to September 2022. At that time, former Bank of Japan Governor Haruhiko Kuroda's comments after maintaining policy unchanged led to further weakening of the yen; but less than an hour after the press conference, the Japanese Ministry of Finance intervened in the market to purchase yen for the first time since 1998. Ueda Kazuo needs to carefully balance his words. Ryutaro Kono, Chief Japan Economist at BNP Paribas, said that given Naoto Takamatsu's tendency to support monetary easing policies and with the elections approaching, Ueda Kazuo may not reveal information about accelerating the pace of rate hikes at this time. But if he is overly dovish, the yen bears will seize the opportunity. Daisuke Karakama, Chief Market Economist at Mizuho Bank, said that the yen plays a crucial role in Japanese monetary policy decisions, a well-known fact. However, at a time when the government needs to defend the currency exchange rate, the yen may once again play this role, which is a cause for "serious concern." Therefore, the Bank of Japan faces a dilemma: on the one hand, it needs to appease the yen bears with hawkish remarks, but on the other hand, it cannot allow bond yields to rise further due to market expectations of Naoto Takamatsu's revitalization of the government through significant spending increases.