BOJ to Hike Rates to 1% in June. Highest Rates in 30 Years Loom, Will Japanese Stocks Plunge and Bear Market Approach?

TradingKey - According to Nikkei, the Bank of Japan is scheduled to raise interest rates at its monetary policy meeting on June 15-16, increasing the policy rate from 0.75% to 1.0%. BoJ leadership, led by Kazuo Ueda, is expected to introduce the rate hike proposal on the 16th, with the resolution anticipated to pass by a majority vote of the nine policy board members.

If the rate hike resolution is approved, it will mark the first increase this year, pushing the policy rate to 1%—the highest level in 30 years since 1995. As Japan enters an era of high interest rates, how will this affect Japanese equities?

Core Inflation Reaches 2.8%: BoJ Behind the Curve on Rate Hike Path

Analysis suggests that this interest rate hike is the result of rising domestic inflationary pressures in Japan. Driven by the conflict in the Middle East pushing up crude oil prices and triggering broad-based price hikes, the Bank of Japan reported that the core inflation rate measured by a new gauge (which excludes government subsidies for education and energy) hit 2.8% in April, exceeding the central bank's 2% target, compared to 2.5% in March.

BoJ insiders noted that due to surging prices, companies are accelerating the pass-through of costs. If the Bank of Japan misses the current window to raise rates, it may be forced to implement sharp increases later. Despite tensions in the Middle East, the resulting downside risks to the Japanese economy remain relatively limited for now; therefore, the primary risk is upward price pressure, and there is a growing inclination within the BoJ toward raising rates.

The Bank of Japan's current rate-hike path is already behind the curve, and former BoJ Executive Director Hideo Hayakawa stated in an interview on Tuesday that it "needs to catch up at some point," with the next rate hike potentially coming "as early as October" following a move in June. Hayakawa also pointed out that due to recent extreme volatility in the Japanese bond market and market concerns over Prime Minister Sanae Takaichi’s persistent stance on fiscal expansion, the BoJ will have no choice but to respond proactively.

In addition to interest rate tools, the Bank of Japan will continue to scale back its JGB purchases, with the current plan running through the first quarter of 2027 and reducing purchases by 200 billion yen each quarter. However, the bank intends to stop the tapering after April 2027 and may purchase JGBs at a monthly pace of 2.1 trillion yen. The BoJ's need to provide a backstop for JGBs stems from recent market instability. As concerns over inflation and fiscal expansion mount, the Japanese bond market has seen continued volatility, with the yield on newly issued 10-year JGBs hitting a 29-and-a-half-year high of 2.8% this May.

Overheated Japanese Stocks and the Era of a Strong Yen: Rate Hikes May Trigger a Bear Market

On June 8, weighed down by a slump in U.S. equities following unexpectedly robust non-farm payroll data, the Nikkei 225 Index opened nearly 4% lower and finished the day down 3.85%, its sharpest decline in three months. According to Nikkei reports, this single-day plunge ranks as the fifth largest in history, trailing only the selloff on April 7, 2025, when Donald Trump announced the imposition of reciprocal tariffs globally. Concurrently, signs of overheating in the Nikkei reached historic highs; on June 3, the index's deviation from its 200-day moving average surged to positive 31%, a peak not seen since May 2013.

Against this backdrop, Japan is poised to enter an era of high interest rates unseen in three decades. How will Japanese equities respond? First, interest rate hikes will drive up borrowing costs for domestic corporations, posing a direct headwind for the market. Compounded by current signs of overheating, signals of further tightening could potentially ignite a bear market for Japanese stocks.

Second, as rate hikes provide momentum for a sharp rally in the yen, the value of yen-denominated Japanese assets could contract significantly in the short term, prompting heavy outflows from foreign funds and pressuring equities. Over the medium to long term, a stronger yen will benefit import-reliant sectors such as food, retail, and energy. However, multinational titans like Toyota, Sony, and Tokyo Electron will face direct foreign exchange losses and immediate headwinds. Since these heavyweights account for a substantial portion of the Nikkei 225 Index, their weakness is expected to exert significant downward pressure on the broader market.