The Bank of Japan (BoJ) is expected to raise interest rates on Friday amid mounting inflationary pressures driven by rising energy prices and a weakening yen, with close attention from the United States. The decision follows recent rate hikes by other major central banks, including the European Central Bank, and comes ahead of the U.S. Federal Reserve’s policy announcement scheduled for Wednesday.

Market expectations suggest the BoJ will increase its benchmark interest rate by 0.25 percentage points to 1.25 percent, the highest level in over 30 years. Some BoJ officials have indicated support for this move, which aims to address inflation nearing the bank’s 2 percent target as of July. The recent surge in oil prices, partly linked to ongoing instability in the Middle East, has heightened concerns over sustained inflationary pressures. Additionally, the depreciation of the yen has raised the cost of imported goods, further contributing to rising prices within Japan.

Takehiko Nakao, former currency chief and former president of the Asian Development Bank, emphasized the need for timely rate hikes to contain inflation. He cautioned that delaying action could necessitate sharper increases in the future. Economic analysts forecast inflation, excluding fresh food and energy, could climb toward 2.5 percent by early 2027. If government subsidies for electricity and gas are not restored, headline inflation may exceed 3 percent. Some experts, including Marcel Thieliant of Capital Economics, anticipate the BoJ’s key rate could reach 2 percent by mid-2027.

The decision also reflects efforts to stabilize the yen, which in July fell to its weakest point against the dollar in 40 years. This decline prompted a rare joint foreign exchange intervention by Japan and the United States to support the currency. The yen’s weakness has been partly attributed to the wide interest rate gap between Japan’s historically low rates and those set by the U.S. Federal Reserve, which attracts investors to higher-yielding dollar assets.

Shigeto Nagai, an analyst at Oxford Economics, described the July intervention as having only a short-lived effect on the yen but resulting in increased pressure on the BoJ to accelerate rate hikes. He noted market perceptions that U.S. Treasury officials expect faster monetary tightening from Japan in exchange for intervention support. The economic and diplomatic costs of disappointing these expectations have become significant considerations for Japanese policymakers.

In August discussions, U.S. officials expressed strong support for Japan’s efforts to implement decisive monetary and market measures to address the yen’s undervaluation. Nakao pointed out that the BoJ’s gradual shift away from ultra-accommodative policies since 2024 has contributed to the currency’s weakness but stressed that a slow pace of normalization risks continuing inflation and economic challenges.

While a weak yen can benefit Japanese exporters by improving price competitiveness, Nakao warned of the negative effects on domestic consumption and investment due to reduced purchasing power. He also highlighted the importance of the Japanese government’s role in reducing its debt levels to maintain market confidence and support currency stability.

The forthcoming BoJ decision is likely to mark a continued shift in Japan’s monetary policy approach as it grapples with inflation dynamics, currency pressures, and external influences in a complex global economic environment.