In a significant turn of events, Japan's economy has returned to growth, clearing the way for the Bank of Japan (BOJ) to hike interest rates further. After a brief contraction in the third quarter of 2025, the world's third-largest economy expanded by an annualized 1.6% in the final three months of the year, according to a Reuters poll. This rebound, driven by robust corporate investment and resilient consumer spending, sets the stage for the BOJ to continue normalizing its ultra-loose monetary policy.
Shifting Tides
What this really means is that Japan's economy is on firmer footing, moving away from the pandemic-induced slump that had plagued it. The BOJ, which raised rates to 0.75% in December, is now widely expected to deliver up to three more hikes this year, according to a senior Mizuho executive. This shift towards tighter policy reflects the central bank's growing confidence in the recovery and its desire to rein in stubbornly high inflation.
Tailwinds for the Yen
The bigger picture here is that a more robust Japanese economy and hawkish BOJ could provide a much-needed tailwind for the beleaguered yen. The currency has struggled in recent years, hitting a 27-year low against the dollar last month. But with the prospect of further rate hikes, the yen could regain some of its lost ground, offering relief to policymakers concerned about the impact of a weak currency on import costs and inflation.
Crucially, this economic rebound also comes as Japan's new prime minister, Sanae Takaichi, prepares to unveil a slate of pro-growth policies. Takaichi, who led her Liberal Democratic Party to a landslide victory in last month's snap election, has promised to boost investment through "proactive" fiscal measures. This combination of monetary and fiscal firepower could provide a powerful catalyst for Japan's economy in the months ahead.
To be sure, challenges remain. Persistent inflation, geopolitical tensions, and global economic headwinds all pose risks. But for now, the tide appears to be turning in Japan's favor, setting the stage for a more confident and dynamic economy in 2026 and beyond.