The Bank of Japan’s Next Rate Hike May Be Its Last for a Long Time

Kazuo Ueda, governor of the Bank of Japan, is expected to raise interest rates this week. (Akio Kon/Bloomberg)

About the author: William Pesek is a longtime Asia opinion writer, based in Tokyo. He is a former columnist for Barron’s and Bloomberg and the author of Japanization: What the World Can Learn from Japan’s Lost Decades*.*

After 26 years of zero interest rates, it all comes down to Friday for Japan’s central bank governor, Kazuo Ueda.

Virtually everyone expects Ueda’s policy board to hike short-term rates to 0.75%, the highest since 1995. That includes Prime Minister Sanae Takaichi, who took office in October determined to dissuade the Bank of Japan from tightening. Her entire economic plan, dubbed “Sanaenomics,” relies on ultralow rates, a weak yen and, yes, more deficit spending.

That was until bond vigilantes pushed back last month, sending bond yields to 18-year highs. Markets buzzed about Japan’s “Liz Truss moment,” a reference to a 2022 bond revolt against the former U.K. prime minister. Takaichi backed down, clearing the way for the BOJ’s second 25 basis-point hike this year.

Yet the odds are high that this is the bank’s last tightening move for a while—perhaps a long while. There are reasonable odds that the BOJ’s next move after Friday might be to cut rates, not raise them. To anyone who is rolling their eyes reading this, I have two words: Toshihiko Fukui.

Fukui was the last BOJ leader to be in the same difficult spot Ueda is in today. Between 2003 and 2007, the Fukui BOJ ended quantitative easing and raised benchmark rates as high as 0.5%. Yet one mild recession and “Lehman shock” later, the BOJ headed back to zero.

When a new BOJ leader took office in 2008, the first course of action was to resume quantitative easing. The world’s biggest ATM was back in business. When Haruhiko Kuroda took over in 2013, he built an even bigger free-money machine and turbocharged the settings.

In the decade before Ueda arrived in 2023, the BOJ cornered the government bond market to the point where no debt issues traded hands on certain days. The BOJ became by far the biggest owner of Tokyo stocks. By 2018, its balance sheet eclipsed Japan’s $4.2 trillion economy. That was a first for a Group of Seven economy.

Ueda has spent his 982 days at the bank’s helm playing history’s riskiest game of Jenga. His team pulls out a block here—say, cutting bond purchases—and a block there, like reducing the BOJ’s epic exchange-traded funds holdings. They are just hoping the whole financial tower doesn’t collapse.

It has been a slow, painstaking process. Too slow for many.

In fact, Ueda erred in not tightening in 2023 and not putting more hikes on the board in 2024. But Kuroda blew Ueda’s endgame. You would think the man who concocted history’s biggest corporate welfare system might have felt compelled to devise an exit or put a interest-rate hike or two on the books for his predecessor. Kuroda didn’t, leaving Ueda to mop up his mess.

Meanwhile, President Donald Trump’s trade war is throwing sand into the gears of Japan’s all-important export engine. Households aren’t appreciating the way Japan traded deflation for stagflation. In the third quarter, its economy shrank 2.3% year-on- year. With wages lagging a 3% annual inflation rate, the BOJ has a valid argument for putting another interest-rate hike on the scoreboard this week. Hence, the bond vigilantes are making their presence known—and not taking no for an answer.

Yet if gross domestic growth flatlines further in 2026 after another tick up in rates, Ueda will have a political firestorm coming his way.

In Japan, the BOJ is the government’s fall guy. In 2007, the Fukui BOJ was blamed for undermining growth with rate hikes. Seventeen years earlier, then-Gov. Yasushi Mieno was left holding the bag when the 1980s bubble economy imploded. It is worth noting that when then-Federal Reserve Chairman Alan Greenspan warned about “irrational exuberance” in 1996, he was referring to Mieno’s tenure.

So, BOJ leaders tend to do their best to avoid being the last one standing when the music stops. The question is, will Ueda find a chair in the year ahead?

There are many risks he should consider in 2026. Trump could escalate his trade war. As the U.S. economy slows, might Trump act on his longtime desire for a weaker dollar? That could blow up the yen-carry trade, whereby investment funds borrow cheaply in Tokyo to bet on higher-yielding assets around the globe.

Geopolitical risks abound, too: Russia expanding its war in Ukraine to a NATO country; China and Japan tensions reaching a fever pitch over Taiwan; a sharp Chinese downturn, should its property crisis deepen; and an oil spike amid renewed turmoil in the Middle East and Venezuela.

By now, most Japan experts admit that a quarter-century of zero rates did more harm than good. Rather than reviving its animal spirits, free money and currency manipulation deadened Tokyo’s urgency to reduce bureaucracy, make labor markets more meritocratic, catalyze a start-up boom, increase productivity, narrow the gender-pay gap, and make Tokyo more hospitable to multinational companies.

Zero rates took the pressure off corporate chieftains to restructure, innovate, and take risks, as Japan Inc. did before QE arrived. It is good that Tokyo prodded companies to tighten corporate governance, which has helped drive the Nikkei 225 Stock Average to record highs. It would be better if Japan Inc. had an answer to Chinese success stories like BYD or DeepSeek or a clearer plan to catch up in the semiconductor race.

Unfortunately, Sanaenomics has little to say about raising Japanese competitiveness. It has lots to say, though, about how Japan’s stint as the world’s ATM should be extended indefinitely. You can see why Ueda faces a difficult gauntlet of political challenges, nevermind the chaotic economic rapids he will encounter next year.

All I’ll say is good luck keeping this latest attempt at policy normalization going.

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