BOJ’s hawkish hold: Another 2026 hike is still on the table

BOJ holds at 1%, but the case for further tightening strengthens

The Bank of Japan (BOJ) kept its policy rate unchanged at 1.0%, in line with market expectations. The decision was approved by an 8-1 majority, with board member Hajime Takata voting for an immediate increase to 1.25%, arguing that upside inflation risks warrant a nimbler policy response.

While the unchanged rate grabbed headlines, BOJ upgraded its FY2026 and FY2027 GDP forecasts, lowered its FY2026 core CPI forecast and raised its FY2027 inflation forecast. More importantly, the Bank continues to expect underlying inflation to remain at or above its 2% target throughout the projection horizon.

Figure 1: BOJ forecasts changed modestly from April

At first glance, the lower FY2026 inflation forecast may appear dovish. However, the downgrade largely reflects temporary government electricity and gas subsidies, rather than weaker underlying inflation. Excluding these administrative effects, inflation continues to broaden, supported by rising wages, resilient domestic demand and continued pass-through of higher import costs.

Taken together, today's meeting reinforces our view that the BOJ's normalisation cycle remains intact. The debate is increasingly about when the next hike comes, rather than whether another hike will happen.

Governor Kazuo Ueda reinforced this message during the post-meeting press conference. He reiterated that the BOJ expects to continue raising rates if the economy and inflation evolve as projected, while warning that delaying policy action could allow underlying inflation to overshoot the 2% target. He also noted that the inflationary impact of Yen weakness may now be greater than in the past, suggesting exchange-rate developments will play a larger role in future policy discussions. This indicates that the BOJ is becoming more attentive to the risk that persistent Yen weakness could generate broader and more durable inflationary pressure.

Market reactions were calm.

Despite the hawkish undertone, financial markets reacted calmly following the policy announcement at around 12:00pm JST.

The Japanese Yen remained broadly stable after the announcement and continued trading near recent lows against the US dollar. Likewise, the Nikkei 225 gave up little ground, having traded higher earlier in the day, supported mainly by gains in semiconductor-related stocks following continued optimism around AI demand. The muted market reaction reflects the fact that the outcome was largely in line with expectations.

The BOJ reinforced the case for further normalisation but offered insufficient evidence that rates would rise materially faster than markets had already anticipated. The Federal Reserve also retains a tightening bias, with markets still pricing additional US hikes after the latest FOMC meeting. As a result, investors continue to focus on the US-Japan interest-rate differential, which remains the dominant driver of the Yen.

The bond market showed a slightly different reaction. Following the announcement, the 2-year Japanese government bond yield remained above 1.5%, while the 10-year yield stayed close to 2.8%, both remaining near multi-decade highs. This suggests investors continue to price in gradual BOJ normalisation over the coming quarters.

Conditions for another 2026 hike remain intact

Today's meeting does not materially change our view on the BOJ's policy path. Instead, it reinforces the framework we outlined in our previous article, "Japan's inflation is heating up. Another BOJ rake hike is becoming harder to ignore".

In the article, we argued that another rate hike in 2026 would depend primarily on two conditions: inflation remaining persistently around or above the BOJ's 2% target, and economic growth holding up despite tighter financial conditions. Today's Outlook Report continues to support both conditions.

Setting aside the subsidy-driven FY2026 CPI downgrade, BOJ upgraded its growth forecasts for FY2026 and FY2027, maintained inflation projections at or above 2% over the medium term, and continued to highlight upside risks to prices. Together, these developments suggest that the conditions for another rate hike later this year remain broadly intact.

The direction of policy is therefore unchanged, with the timing of the next hike increasingly data dependent. If inflation remains persistently above target while economic activity stays resilient, the conditions for an additional rate hike later in 2026 would remain in place. Conversely, a meaningful deterioration in growth would likely delay further policy normalisation.

Table 1: Potential triggers for a second BOJ rate hike in 2026

Scenario	Growth	Inflation	BoJ Response
Gradual normalisation	Moderate slowdown, but no recession	Near 2% target	Continue gradual, data-dependent normalisation
Second hike later in 2026	Resilient growth and consumption	Persistently above 2% target	One additional hike becomes more likely
Faster tightening	Any trajectory	Inflation materially overshoots target	BoJ may accelerate tightening
Pause	Sharp deterioration	Any trajectory	Pause further tightening to assess growth risks

Yen outlook remains dependent on the US-Japan rate gap

Today’s meeting does not materially change our framework for assessing the Japanese Yen. Japan’s improving domestic fundamentals, including resilient growth, broadening inflation and stronger wage dynamics which continue to support gradual BOJ policy normalisation.

However, USD/JPY remains highly sensitive to the US-Japan interest-rate differential. Both the BOJ and Federal Reserve continue to signal the possibility of further tightening, leaving the Yen’s near-term direction dependent on  how incoming economic data alters expectations for the relative policy paths of the BOJ and Federal Reserve.

Stronger Japanese inflation, wages and domestic demand could bring forward expectations of another BOJ hike. Conversely, softer US inflation or labour-market data could reduce expectations for further Federal Reserve tightening. Either development could narrow the rate differential, although the timing and magnitude remain uncertain.

Figure 2: Surprise interventions provide only temporary Yen support

Table 2: Has our Yen thesis changed since April?

Factor	April view	Current assessment	Verdict
Intervention	Could curb excessive Yen selling.	Support proved temporary.	Unchanged: Limits volatility, not the broader trend.
Domestic economy	Wages and consumption supported BOJ normalisation.	Growth and inflation remain resilient.	Unchanged: Fundamentals still support gradual tightening.
Structural agenda	Investment reforms could strengthen long-term growth.	Plans remain intact; fiscal flexibility is tighter.	Broadly unchanged: Execution and funding discipline are increasingly important.
US-Japan rate gap	Expected to narrow as BOJ tightened.	Higher US yields offset BOJ tightening.	Changed: The wide rate gap still pressures the Yen.
Source: iFAST compilations.

Overall, our April framework remains broadly intact. Japan’s domestic fundamentals continue to support BOJ normalisation and our slightly positive longer-term view on the Yen. However, the near-term Yen’s direction remains dependent on whether the US-Japan interest-rate differential narrows. Investors should therefore focus on incoming inflation, wage, growth and policy data from both economies rather than assume a clear directional move.

Staying constructive on Japan, led by small and mid-caps

Overall, our investment view is unchanged. Resilient growth, improving wages and increasingly domestically generated inflation continue to support gradual BOJ normalisation, keeping the possibility of another rate hike later in 2026 in play.

We remain constructive on Japanese equities, particularly small- and mid-cap companies. Unlike large exporters, these companies derive a greater share of earnings from the domestic economy and are less dependent on Yen weakness for profit growth. They should benefit from continued wage gains, resilient consumption and business investment, while gradual monetary normalisation reflects improving economic fundamentals rather than excessively restrictive policy.

As Japan moves away from decades of ultra-loose monetary policy, domestically oriented companies remain well positioned to benefit from the country’s improving structural outlook.

Table 3: Recommended products

Japan	Eastspring Investments - Japan Dynamic Fund Amova Japan Equity Fund
Smaller Japanese companies	Janus Henderson Horizon Japanese Smaller Companies BNP Paribas Japan Small Cap Classic Cap