Japan’s Trade Deal with U.S. Boosts BOJ Rate Hike Prospects

Japan’s trade agreement with the United States is fueling expectations that the Bank of Japan (BOJ) may raise interest rates later this year. Sources familiar with the central bank’s stance suggest the deal reduces uncertainty over U.S. trade policy, paving the way for a potential policy shift as early as October.

While optimism is rising, officials remain cautious. The BOJ will closely monitor how U.S. tariffs impact Japan’s economy, which has been weakened by sluggish consumption, higher living costs, and fragile manufacturing output. Analysts expect upcoming data, including October’s “tankan” business survey, to be key in determining the timing of any rate hike.

Deputy Governor Shinichi Uchida recently signaled a more positive outlook, citing improved prospects for achieving the BOJ’s 2% inflation target amid rising food prices. This marks a shift from earlier warnings by Governor Kazuo Ueda about heightened uncertainty. Economists, including JP Morgan’s Ayako Fujita, anticipate an upward revision to inflation forecasts at the BOJ’s July 30–31 policy meeting, though rates are expected to remain unchanged for now.

Japan exited its decade-long ultra-loose policy last year, lifting rates to 0.5% in January. However, real interest rates remain negative, and internal divisions persist within the BOJ between hawks pushing for faster hikes and cautious members wary of economic risks.

Markets are already pricing in a near-term hike, with two-year government bond yields hitting a four-month high. Despite the trade deal, U.S. tariffs could still shave 0.55 percentage points off Japan’s annual GDP growth, according to former BOJ board member Takahide Kiuchi. The central bank is expected to signal gradual policy normalization, balancing inflationary pressures with ongoing economic vulnerabilities.