In a surprising move, the Bank of Japan (BOJ) raised interest rates on Wednesday and introduced a comprehensive quantitative tightening (QT) plan, signaling a significant shift away from a decade of aggressive monetary stimulus. This decision marks a departure from market expectations, which had largely anticipated that the BOJ would maintain its current rate policy.

The BOJ’s board decided to increase the overnight call rate target to 0.25%, up from the previous range of 0-0.1%. This marks the first time since 2008 that the BOJ has set its short-term policy rate at this level. The decision, which was made with a 7-2 vote, underscores the BOJ’s growing confidence in the economy’s recovery and its intention to curb inflationary pressures.

Additionally, the BOJ announced a detailed QT plan, aiming to reduce its monthly bond purchases from the current 6 trillion yen to approximately 3 trillion yen by the first quarter of 2026. This reduction represents a significant shift in the BOJ’s approach to managing liquidity and signals a move towards normalizing its monetary policy.

Following the announcement, the yen experienced volatility, initially rallying as much as 0.8% to a three-month high of 151.58 per dollar, before stabilizing. Yields on 10-year Japanese government bonds also fell slightly.

In its statement, the BOJ attributed the rate hike to broadening wage increases, which are prompting firms to raise prices for services, thereby contributing to inflation. The bank also noted that import prices are once again accelerating, highlighting the risk of an inflation overshoot.

The BOJ’s quarterly outlook report, released alongside the rate decision, maintained the projection that inflation would hover around 2% through fiscal 2026. This aligns with the BOJ’s inflation target, indicating a sustained period of moderate price increases.

BOJ Governor Kazuo Ueda is expected to hold a news conference to provide further details and context for the decision. The timing of the BOJ’s actions is notable, as it contrasts with the U.S. Federal Reserve’s recent signals of potential rate cuts as early as September, which could reverse some of the aggressive rate hikes seen in recent months.

The BOJ had already made a significant policy shift earlier in the year by ending its negative interest rate policy and its control over bond yields. Governor Ueda has indicated that further rate hikes could be on the horizon if wage growth and inflation trends continue as projected. The BOJ aims to reach a neutral rate level that neither stimulates nor restrains economic growth, potentially within the 0.5% to 1.5% range, depending on future inflation dynamics.