BoJ set for next interest rate rise – Japan’s stock market in the new monetary policy environment

• Joël Le Saux
  Portfolio Manager
  Eurizon

As this move is widely anticipated, the decision itself is likely to have only a limited impact on the market. What will be decisive, however, is the central bank’s communication: market participants have recently adjusted their expectations for further interest rate rises and are now anticipating quarterly increases through to next summer, meaning the key interest rate is likely to stand at 2 per cent by then.

After three years of solid performance – with annual gains of over 20 per cent – the strong results for 2026 can be attributed to several factors. Double-digit earnings per share growth for 2026 and 2027 appears to be the main reason for this sustained rally. Technology companies, which are heavily weighted in the TOPIX, are making a significant contribution. Companies in the industrial and materials sectors are also benefiting from investment in artificial intelligence.

The normalisation of monetary policy is part of a broader shift in policy in Japan. Over the past two years, the BoJ has raised its key interest rates, whilst the medium- to long-term yield curve has already largely normalised. Amongst others, this is benefiting banks, which have high excess liquidity and bond portfolios with short durations. In general, Japanese companies are gaining increasing pricing power.

The corporate governance reforms are structural in nature. Companies still have scope to deliver higher returns to shareholders, as their payout ratios remain low by international standards. The reduction of cross-shareholdings, a stronger focus on return on equity and increasingly shareholder-friendly corporate governance are therefore shaping the Japanese equity market narrative just as much as the normalisation of monetary policy.

The recent appreciation of the yen has also taken most market participants by surprise. However, at around 153 yen to the US dollar, the currency remains within its two-year range of 145 to 160 yen. The yen’s weakness above 160 yen at the start of the summer was probably unfounded. At current levels, the impact on corporate profits is likely to remain limited. Most companies have based their profit forecasts for 2026 on an exchange rate of 155 yen. The expected growth in TOPIX earnings for 2026 and 2027 should therefore remain largely unchanged.

Following its strong performance, the Japanese equity market is no longer cheaply valued. However, current valuations appear reasonable given the expected earnings growth. Double-digit EPS growth seems plausible to us. Domestic companies appear attractive from a valuation perspective, but their market capitalisation accounts for less than a quarter of the TOPIX and they are generally not mega-caps.

The Japanese equity market is more broadly based than the US market. The largest company has a weighting of 4 per cent, whilst the second-largest accounts for just 2.5 per cent. By way of comparison, the three largest US companies together account for more than 20 per cent. Compared with Europe, the technology sector is significantly more heavily weighted in Japan. The Japanese market therefore offers good diversification opportunities for global investors.

The shift in policy is structural in nature. We see no reason why this tailwind should suddenly reverse. Japan is in a virtuous cycle of wage growth that is largely keeping pace with underlying inflation, a normalisation of monetary policy and increasingly investor-friendly behaviour on the part of companies. This includes higher dividends for shareholders, the reduction of cross-shareholdings and a stronger focus on return on equity. Furthermore, a growth-oriented mindset is increasingly taking hold in the boardrooms of many companies. This development is new and is likely to support future earnings growth.