On December 19, 2025, the Bank of Japan (BOJ) (8301.T) raised its key interest rate to 0.75%, representing the highest increase since 1995. In a not so hawkish tone, BOJ reiterated that the current wage‑price momentum justified the hike as underlying inflation maintains a moderate uptick, staying above the BOJ’s 2% target for months on end.
How did the market react to this?
Yen weakened for a short period, moving down to 156 per USD, but soon lost its momentum and was sold by the market that had already priced in the interest rate hike.
However, Japan’s 10-year yield surged to 2%, a position considered to be the highest in 9 years! This occurred despite Japan’s economy contracting by ‑0.6% Q-o-Q and ‑2.3% annualized.
What is in it for the foreign fixed-income investors in Japanese instruments?
Weeks after this historic benchmark interest rate hike, foreign investors in Japanese fixed-income assets such as government bonds (JGBs), corporate bonds, municipal bonds, and other debt securities will be closely monitoring its impacts on both their short-term or long-term positions.
- Japanese government bonds (JGBs): Immediately after the policy rate was raised, 10-year JGB yield rose significantly to 2.015%, a level considered to be the highest since 1999. And with the removal of Yield Curve Control (YCC) in 2024 by Japan, and prospects of more rate hikes in 2026, investors may be in for an upward yield ride.
- Corporate bonds: The corporate bonds are a combination of JGBs and credit spreads. Therefore, the higher JGB’s 10-year yield also resulted in higher corporate bonds’ yields, leading to lower bond prices. As BOJ is scaling back its bond purchases, this creates a weaker demand and auctions in the bond market, causing liquidity issue. Although, corporate’s credit stability is heightened due to high corporate profit levels.
- Other debt securities: Other debt securities such as municipal bonds, financial institution bonds, asset‑backed securities (ABS), mortgage‑backed securities (MBS), commercial paper (CP), and bank loans and floating‑rate notes are also impacted by the new rate policy. It expressly becomes more expensive for municipalities to issue their bonds; bank bonds will result in higher mortgage and loan costs; ABS/MBS will cause loan costs to go up; commercial paper will experience tighter liquidity but leading to higher short-term yields; and, though floating-rate notes will become more attractive but they come at higher coupons.
What does 2026 hold for investors?
According to BOJ Governor, Ueda Kazuo, Japan will take a slow and cautious step in normalizing its fiscal policies, and future key interest rate hikes will have to be justified by a number of factors such as sustained wage growth and strong economic conditions that support tightening. More importantly, since the current benchmark rate is still below Japan’s neutral rate, there is possibility of a rate hike in 2026 or in a multi-year approach.
The short-term to long-term outlook of the rate hike
- Short-term: Yen may weaken or mildly strengthen against the USD. Though, in reality, four days after the hike, Yen has continued to strengthen against the greenback, from 157.65 to 155.74.
- Medium-term: As the U.S. dollar faces a couple of rate cuts or more in 2026, Yen is poised to maintain its strength.
- Long-term: BOJ Governor, Ueda Kazuo has indicated that the BOJ has fixed its gaze on raising the benchmark rates in 2026, and this may signal higher, sustained JGB yields and higher volatility in Japanese bond market, a move that could increase the costs of Yen funding, increase or erase returns, and make carry trade unattractive to investors.
Benzinga Disclaimer: This article is from an unpaid external contributor. It does not represent Benzinga’s reporting and has not been edited for content or accuracy.
