Bank of Japan is expected to deliver a hawkish hike, pressured by rising inflation

• The Bank of Japan is set to hike interest rates to 1.25%, the highest level in 31 years.
• Higher inflation, strong GDP data and pressure from the US administration are pushing the BoJ to step up its tightening pace.
• The US Dollar has pared some losses this week, fuelled by the Fed’s hawkish monetary policy stance.

The Bank of Japan’s (BoJ) monetary policy meeting will close a week packed with central bank decisions on Friday, with markets particularly interested in confirming expectations of a hawkish shift that has boosted a strong Japanese Yen (JPY) recovery in September.

Futures markets are practically fully pricing a quarter-point rate hike this time, which would push the BoJ’s benchmark interest rate to its highest level in about 31 years, amid higher inflation, rising wages, and pressure from US Treasury Secretary Scott Bessent.

The Japanese central bank will follow the Federal Reserve (Fed) and the European Central Bank (ECB) in tightening monetary policy as the war in the Middle East fuels global inflation. The Strait of Hormuz remains practically closed, and recent developments threaten the Red Sea alternative route, pushing Brent Oil prices above $100 and spurring serious concerns about supply disruptions.

What to expect from the BoJ interest rate decision?

Barring a highly unlikely surprise, the Bank of Japan will raise its benchmark interest rate from 1% to 1.25% on Friday, drawing monetary policy closer to levels the bank considers neutral for the Japanese economy. The decision is likely to obtain the support of the broad majority of the Policy Board, with recently appointed committee member Toichiro Asada likely to dissent, as he did at June’s meeting.

Rising inflationary pressures, among other reasons, have prompted the BoJ to accelerate its monetary tightening pace. So far, the bank has kept a semi-annual hiking pace, while September’s rate increase, if confirmed, would follow a previous one in June. Markets have speculated on a half-point rate hike, but considering the cautious approach to monetary policy of the Japanese central bank, that option seems out of the question.

Japan’s Consumer Price Index (CPI) data from July revealed that prices grew at their fastest pace in the last seven months, reaching 1.9%, just below the BoJ’s 2% target for price stability. Beyond that, wages have continued rising, which hints at stronger price pressures in the near-term, altogether heightening the risk that the central bank might fall behind the inflation curve if it sticks to the gradual tightening path seen hitherto.

Japan’s broader economic outlook remains supportive too. The Gross Domestic Product (GDP) beat expectations in the second quarter, with a 1.4% annualised growth, providing fairly favourable conditions for some monetary tightening.

Against this backdrop, investors are waiting for the bank to deliver a clear message outlining a firmer monetary policy normalisation cycle ahead. This would come after less-than-subtle pressures from the US administration, following an exceptional coordinated intervention between the US and Japan in Forex markets that halted a long-lasting Yen decline in late July.

Analysts at ING, however, warn that the market might be overestimating BoJ’s hawkishness, arguing that Japan’s “aggressive pro-growth strategy” will act as a brake on any rapid shift to tighter policy by the BoJ. They note that the government “will no doubt express its views against a more aggressive tightening cycle,” adding that it is “hard to see government officials backing a much faster tightening cycle of either a 50bp hike in September or back-to-back hikes in September and October.”

How could the Bank of Japan's monetary policy decision affect USD/JPY?

USD/JPY is showing a 2.5% decline in September so far, as a series of hawkish comments by BoJ officials has prompted traders to ramp up bets on a steeper BoJ tightening cycle. This has triggered a massive short covering in Japanese Yen, with large speculators flipping their net positioning to long JPY for the first time since February.

The US Dollar (USD) has managed to regain some ground this week. The Federal Reserve (Fed) provided a fresh boost to the Greenback on Wednesday by hiking interest rates and pointing to further tightening in coming months, but the broader near-term bias remains bearish.

The USD/JPY pair has returned above the neckline of a bearish Head & Shoulders (H&S) pattern, following a post-Fed rally, but is struggling to get past a previous support-turned-resistance at the 156.75 area, which keeps the broader bearish structure in place. Momentum indicators on the daily chart endorse the bearish view, as the Relative Strength Index (RSI) remains below the 50 level and the Moving Average Convergence Divergence (MACD) is below zero, suggesting rallies are likely to find sellers.

Bulls should confirm above the mentioned H&S neckline at 155.20 and the September 4 high at 156.76 to clear the path towards the area between the previous support zone around 158.00 and the 200-day Simple Moving Average (SMA), at 158.41.

A reversal below 155.20, on the contrary, would confirm the H&S formation, adding pressure towards the 2026 lows near 152.00. The H&S’s measured target lies around the October 2025 lows, at 146.60.