Bank of Japan Set to Raise Rates by the Most in 18 Years: Will It Be 'Black Swan' Again?

The Bank of Japan (BoJ) is widely expected to raise its benchmark interest rate this Friday by the largest amount in 18 years, as Japan's economy shows signs of recovery and persistent inflation.

It's worth noting that the last time the BoJ raised rates, in July, it sparked a global sell-off in assets as large carry trades unwound. The S&P 500 corrected nearly 10% through early August.

This time, the anticipated move—a 25 basis point increase to 0.5%—would mark the largest rate hike since February 2007, signaling that Japan's economy may finally be returning to normal.

Governor Kazuo Ueda and his board are likely to finalize the decision following their two-day meeting, with market indicators suggesting a 100% probability of the rate hike. This represents a sharp rise from the end of last month when traders gave the hike only a 40% chance. About three-quarters of economists now predict the hike, a jump from around half in previous months, according to Bloomberg.

"The only hurdle for the BoJ raising rates this week was the risk from Trump, but so far we have not heard anything from him on Japan, and the market has been very stable. Nothing can prevent the BoJ from moving this week," said Masamichi Adachi, chief Japan economist at UBS.

While the rate hike is widely expected, a key focus for investors will be how Ueda outlines the future trajectory for rates, as Japan's borrowing costs remain among the lowest in developed nations. Ueda's policy statement, which will be released alongside the BoJ's quarterly economic forecast, is expected to indicate further rate hikes as part of a broader plan for gradual monetary tightening through March 2027. The bank's inflation outlook is also expected to be revised upward, signaling greater confidence in sustained inflation.

However, while Ueda is likely to avoid providing a specific rate path to keep options open, he faces the challenge of balancing market expectations. A statement that appears too dovish could weaken the yen, potentially exacerbating inflationary pressures and prompting Japan's currency authorities to intervene in the markets.

The BoJ's decision could also have a ripple effect on Japan's banking sector, where major banks have already seen significant gains. For the first time in nearly a decade, Japan's biggest banks—MUFG, SMFG, and Mizuho—are trading at or above their book value. This comes amid growing expectations that the BoJ will continue its policy normalization. MUFG, Japan's largest bank by market capitalization, is trading above its book value, a key indicator that investors view the bank as being worth at least as much as the assets on its balance sheet.

The surge in bank valuations is attributed to continued expectations of rate hikes, which would help improve banks' margins, particularly after years of Japan's negative interest rate policy. The policy, which was ended in early 2024, had previously suppressed bank valuations by narrowing the gap between what banks could charge on loans and what they paid to Japanese depositors.

Goldman Sachs forecasts that the price-to-book ratio for Japan's megabanks could reach 1.1-1.2 times by mid-2025. While Japan's smaller regional lenders are still trading at a fraction of their book value, the country's largest banks are poised to benefit from the BoJ's policy shift and from expanding business abroad. For example, MUFG generates more than half of its revenue from international markets.

For the BoJ, the challenge will be managing expectations and ensuring that the rate hikes do not inadvertently disrupt economic growth or financial stability. The market will be watching closely for any signals from Ueda about the potential for future hikes and how the BoJ plans to navigate global risks, including the impact of U.S. economic policy under Trump's administration.