BoJ's Next Move: A Second-Half 2026 Hike is the Base Case

The Bank of Japan's December move was a landmark event, raising its policy rate to 0.75%-its highest level since 1995. The unanimous vote signaled a definitive shift toward a more hawkish stance, with the central bank stating it would continue to raise rates if its forecasts materialise. Yet the immediate data following the hike presents a complex and conflicting picture, creating a clear wait-and-see environment for markets.

On the surface, the inflation narrative is cooling. Tokyo's headline consumer price index slowed to 2.0% year-on-year in December, falling below expectations. This deceleration was driven by temporary factors, including renewed energy subsidies and falling rice prices. More broadly, the BoJ's own forecast sees inflation decelerating to the range of 1.5-2.0% for fiscal 2026. Core inflation, which excludes fresh food and energy, also slowed to 2.6% in December. This data suggests the central bank's recent hike may have already had a dampening effect, prompting caution.

The core tension is between the BoJ's stated hawkish intent and the weakening inflation momentum. The central bank's forecast for a terminal rate consistent with its estimated neutral range of 1% to 2.5% implies more room to hike. However, the recent data on headline inflation dropping below 2% and core inflation easing toward 2% creates a clear disincentive for an immediate follow-up move. The bank is likely to carefully assess the impact of its previous rate increases before committing to another.

The consensus view, therefore, is that the next hike is unlikely to come before the second half of 2026. Analysts point to the need for more information from Japan's spring wage negotiations, known as the Shunto, as a key input. With strong wage growth plans and government aid expected to keep core inflation above 2%, the BoJ will need to confirm that underlying price pressures remain durable before acting. For now, the market is in a holding pattern, awaiting clearer signals from both inflation data and the central bank's next communication.

The Mechanics: Why the Wait is Tactical

The Bank of Japan's cautious pause is not a sign of weakness but a deliberate wait for confirmation. The recent drop in inflation is being driven by temporary factors that are expected to fade, not by a structural shift in price pressures. Headline inflation cooled to 2.0% year on year in December, below expectations, primarily due to renewed energy subsidies, stable rice prices, and low petroleum costs. These are policy-driven and cyclical effects; the government is actually increasing winter energy subsidies, and rice prices are continuing to fall. This creates a near-term floor for inflation, keeping it low into 2026. The BoJ is therefore waiting to see if core inflation, which excludes these volatile items, can sustainably hold above its 2% target once these temporary supports are removed.

The critical near-term catalyst for the BoJ is the outcome of the 2026 spring wage negotiations, known as Shunto. Labor unions are demanding aggressive hikes, with the Japanese Trade Union Confederation (Rengo) reportedly seeking wage hikes of 5% or more. This is a key part of the central bank's "virtuous cycle" thesis, where strong wage growth underpins consumer spending and stabilizes inflation. Governor Ueda has explicitly stated he wants "a bit more data" on the initial momentum of these talks. The outcome will be a major signal: sustained wage growth above 5% would provide the confidence the BoJ needs to proceed with further rate hikes, as it would demonstrate that inflation is being driven by underlying demand, not just temporary subsidies.

At the same time, a separate fiscal risk is building. The new Takaichi administration is pursuing a record expansionary budget, which is already pushing up long-term borrowing costs. The government's latest projections show a record 122.3 trillion yen budget for fiscal 2026, and this massive stimulus is heightening market concerns over debt over-supply. This fiscal push is directly contributing to a surge in Japan's 10-year government bond yield, which has climbed for six consecutive years. Higher long-term yields increase the cost of servicing Japan's already enormous public debt, which is more than twice the size of its economy. This fiscal pressure creates a risk of a weaker yen, which in turn could fuel imported inflation and complicate the BoJ's exit strategy.

The bottom line is a tactical wait. The BoJ is caught between temporary disinflation and the need for a durable inflationary foundation. It is waiting for the Shunto outcome to confirm that wage-driven demand is robust enough to sustain core inflation above 2% once energy subsidies expire. Any misstep in this delicate balance-either a failure to raise rates when inflation is structurally supported, or a premature hike that triggers a sharp yen sell-off and higher import costs-could derail the normalization path. For now, the central bank is gathering data, and the market is pricing in a slow, deliberate pace of tightening.

The Setup: A Second-Half 2026 Hike is the Likely Path

The Bank of Japan's path to a second-half 2026 rate hike is now the most logical scenario, hinging on its own baseline forecast that inflation will stabilize around its 2% target. The central bank's own projections provide the floor for further tightening. According to its latest outlook, the year-on-year CPI rate is expected to decelerate to a range of 1.5-2.0% for fiscal 2026 and then move to around 2 percent for fiscal 2027. This forecast, which sees inflation hitting its target, is the key condition the BoJ has set for continuing its normalization. If this outlook materializes, the bank has stated it will continue to raise the policy interest rate.

The current monetary stance provides ample room for this next move. Even after the December hike to 0.75%, the central bank noted that real interest rates are expected to remain significantly negative. This means the economy still benefits from highly accommodative financial conditions, giving the BoJ the flexibility to proceed gradually. The bank has estimated its neutral rate-the level where policy neither stimulates nor restrains growth-in a range of 1.0% to 2.5%. With the policy rate at 0.75%, the next hike would bring it closer to the lower bound of that neutral zone, a logical step if inflation is on track.

Given this setup, the most likely timing aligns with the BoJ's own forward-looking framework. The central bank has emphasized that any further tightening depends on its "degree of confidence" in achieving the 2% target. The most immediate catalyst for a decision would be the results of the spring wage negotiations, known as the Shunto, which typically occur in the first half of the year. However, the bank has also indicated that a rate hike remains on the table if high uncertainty does not darken the outlook. With the December hike now behind it and the first half of 2026 providing a window to assess inflation data and wage pressures, the July meeting emerges as the most probable date for the next move. This would position the BoJ to complete a gradual tightening cycle in the second half of 2026, bringing its policy rate into the neutral range as its inflation forecast is realized.

Catalysts and Risks: What Could Move the Timeline

The Bank of Japan's next rate move hinges on a few specific data points and events that could accelerate or delay its gradual normalization. The central bank has signaled it is ready to hike further if wage growth proves robust enough to sustain inflation, but it is also cautious about the timing.

The most immediate catalyst is the outcome of Japan's annual wage negotiations, known as Shunto. A stronger-than-expected settlement could prompt an earlier hike, potentially in the second quarter of 2026. Labor unions, led by the Japanese Trade Union Confederation (Rengo), are seeking wage hikes of 5% or more for 2026. While companies have counteroffered with a 5.5% increase, the final settlement is not expected until March. Governor Kazuo Ueda has stated he wants "a bit more data" on this momentum before committing to a rate increase. If the final average exceeds 5%, it would provide the "virtuous cycle" of wage-driven consumption that the BoJ seeks, giving it the confidence to act sooner rather than later.

A second, more structural risk is persistent yen weakness or a sharp rise in Japanese government bond (JGB) yields due to fiscal concerns. The 10-year JGB yield has already surged to around 2%, its highest level in over two decades, amid worries over Japan's massive public debt. If market concerns about fiscal health intensify, pushing yields higher and weakening the yen further, the BoJ may feel compelled to raise rates earlier to stabilize its currency and bond markets. The central bank has already warned that low rates have weakened the yen and pushed up long-term yields, creating a self-reinforcing pressure.

The BoJ's next major data point will be its policy meeting on April 30-May 1. At this meeting, the bank will release updated economic forecasts, including its latest projections for inflation. This is a critical juncture. The central bank's own Point-in-Time data shows its forecast for 2026 core inflation has already ticked up to 2.0%. If the updated forecasts show inflation staying above 2% and outpacing headline inflation, it would reinforce the case for a hike. Conversely, if the forecasts are revised lower due to cooling Tokyo inflation or other factors, the BoJ would likely remain cautious.

The bottom line is a timeline that is not set in stone. The path forward depends on the interplay between wage data, currency stability, and bond market pressures. While the BoJ has a gradual, data-dependent path, specific events like a strong Shunto outcome or a fiscal scare could compress that timeline significantly.