Japan Is Leaving the Era of Ultra-Low Interest Rates for Good

According to the Bank of Japan, consumer prices excluding fresh food are expected to rise by around 2.5% in fiscal 2026 and 2.4% in 2027. By 2028, inflation is expected to approach 2%. Meanwhile, the central bank’s July forecast projects real GDP growth of 0.6% in 2026 and approximately 0.8% in both 2027 and 2028. The Bank of Japan links persistent inflationary pressure to higher oil prices, a weaker yen, and growing demand for semiconductors and other goods related to the development of artificial intelligence. The central bank also explicitly notes that underlying inflation is gradually settling around its 2% target.

The current situation differs markedly from the conditions that prevailed in the Japanese economy for most of the past few decades. For a long time, the main goal of monetary policy was to overcome sluggish price growth and deflationary expectations. Now the challenge is shifting in the opposite direction. The Bank of Japan must prevent inflation from accelerating excessively while preserving conditions for moderate economic growth. The Financial Times notes that weak real income growth and the risk that rate hikes that are too rapid could dampen domestic demand add to the challenge.

Financial markets are already starting to price in the possibility of further increases in borrowing costs. According to analyst estimates cited by Reuters, the rate could rise to 1.5% by March 2027 and to 1.75% in the second quarter of that year. The Bank of Japan itself is avoiding a firm course for now, emphasizing that future decisions will depend on inflation, the state of the economy, and financial conditions. Governor Kazuo Ueda has also noted that the pace of further tightening may vary depending on price trends.

Japan’s shift to higher interest rates is gradually changing the familiar structure of global financial markets. For many years, investors used cheap yen funding to invest in higher-yielding overseas assets. As Japanese rates rise, these strategies are becoming less attractive, while domestic bonds are drawing more interest from Japanese investors. The normalization process is likely to remain cautious. Economic growth is still moderate, limiting the Bank of Japan’s ability to raise rates quickly. However, with inflation settling around 2%, a return to the previous era of near-zero borrowing costs is becoming increasingly unlikely.

Author: Assistant, Department of World Economy and International Finance, Financial University under the Government of the Russian Federation, Nikita Dmitrievich Klevanets.