Bank of Japan Raises Rates to 0.75%, Highest Since 1995, as Ultra-Loose Policy Ends Amid Fiscal Stimulus Concerns

On December 19, the Bank of Japan (BOJ) raised its policy rate by 0.25 percentage points to 0.75%, marking the highest level since September 1995 and signaling the end of its ultra-loose monetary policy era. This pivotal shift aims to break Japan’s prolonged cycle of low interest rates, low inflation, and stagnant growth.

The decision follows 44 consecutive months of inflation exceeding the BOJ’s 2% target, alongside persistent yen weakness fueling imported inflation pressures. However, market unease stems from a stark policy mismatch: while the BOJ tightens monetary policy, Prime Minister Takaichi Sanae’s cabinet unveiled a ¥18.3 trillion fiscal stimulus package—Japan’s largest post-pandemic spending plan.

Liu Ying, a researcher at Renmin University’s Chongyang Institute for Financial Studies, described the rate hike as a "dangerous leap." The clash between monetary tightening and fiscal expansion risks undermining the BOJ’s inflation fight while exacerbating Japan’s debt burden, already the highest among advanced economies at 229.6% of GDP.

Global markets are bracing for ripple effects, particularly from unwinding yen carry trades. Speculative investors, including Japan’s retail "Mrs. Watanabe" traders, have already retreated, with CFTC data showing a 60% drop in yen net short positions ahead of the hike.

The BOJ’s move reflects structural shifts: rising service prices, a 5.25% wage hike in this year’s "shunto" negotiations, and a weak yen near ¥155/USD. Yet, with Q3 GDP contracting 2.3% annualized, analysts warn that higher rates could stifle Japan’s fragile recovery.

The ¥18.3 trillion stimulus—60% debt-funded—will face soaring borrowing costs as 10-year JGB yields hit 2%, a 2006 high. The IMF projects Japan’s interest payments could double to ¥16.1 trillion by 2028.

While some deem carry-trade risks manageable (speculative yen shorts are just 40% of July 2024 levels), Liu Ying anticipates a global liquidity shift toward "low-carry, high-allocation" strategies, with capital potentially repatriating to Japanese assets.