Strong Momentum Amid Policy Normalization
The Nikkei 225 index has continued to deliver impressive performance throughout the second half of 2025, supported by a combination of domestic fundamentals and global dynamics. Investor sentiment remains positive even as the Bank of Japan (BOJ) cautiously moves toward policy normalization after years of aggressive stimulus.
On the fundamentals side, the latest data shows Japan’s output gap for Q2 2025 was revised to +0.3%, the highest since 2019. This indicates that economic activity has exceeded its long-term potential, signaling a recovery in domestic demand. Meanwhile, core inflation fell to 2.7% in August, down from around 3% previously, but still above the BOJ’s 2% target. The combination of moderate inflation and strong economic activity has provided optimism for Japanese equities.
From a policy perspective, the BOJ has kept its benchmark interest rate at 0.5%, relatively low compared to other major central banks. However, its decision to gradually unwind ETF and REIT holdings marked the beginning of the end for the ultra-loose policy era. Even so, the cautious approach has prevented market shocks, maintaining investor confidence.
External factors have also strengthened Nikkei’s momentum. A weaker yen continues to support exporters, particularly in the automotive and technology sectors, which form the backbone of the index. In addition, expectations that the U.S. Federal Reserve will continue cutting interest rates have boosted global capital flows into equities, including Japan.
Looking ahead, the direction of the Nikkei 225 will likely depend on the balance between inflation, domestic wage growth, and BOJ policy. In an optimistic scenario, if inflation stabilizes around 2–3% and domestic consumption strengthens, the index could climb to the ¥50,000–¥52,000 range within the next 6–12 months. However, risks remain. Should the global slowdown worsen or the BOJ tighten policy more aggressively, the Nikkei could correct to the ¥43,000–¥45,000 range.
Thus, the Nikkei 225 is now in an important transition phase: supported by relatively solid fundamentals on one side, while facing the challenges of policy normalization and global risks on the other. For investors, the Japanese market remains attractive, but an adaptive strategy toward monetary policy and global conditions will be key to capturing opportunities.
Key Drivers of Growth
- Weaker Yen
The yen’s depreciation against the U.S. dollar benefits Japanese exporters, as overseas earnings translate into higher yen-denominated revenue. - Global and Monetary Optimism
Lower-than-expected U.S. inflation data has strengthened hopes of Fed rate cuts, encouraging investors to return to risk assets such as equities. - Easing Trade Tensions
Reduced trade tensions across countries have created a more favorable market environment. - Technology & Export Sector Strength
Japanese semiconductor, automotive, and technology companies have shown strong performance driven by solid global demand. - Supportive Domestic Policy Outlook
Potential for additional fiscal or monetary stimulus has boosted investor confidence in domestic growth prospects. - Foreign Investment Inflows
Attractive valuations, combined with yen weakness, have spurred stronger foreign investor interest in Japanese equities.
Nikkei 225 Forecast / Projection
Bullish Scenario (Optimistic)
- Supporting conditions: Inflation moderates at 2–3%, domestic consumption strengthens, BOJ normalizes policy gradually, global conditions remain stable.
- Potential level: Nikkei rises 5–15% toward ¥50,000–¥52,000 within 6–12 months.
- Risks: Inflation spikes, global interest rates rise sharply, rapid yen appreciation, economic slowdown in the U.S. or China.
Neutral Scenario (Sideways)
- Supporting conditions: BOJ remains cautious, inflation eases toward target, global economy stagnates without major shocks.
- Potential level: Nikkei trades between ¥45,000–¥50,000.
- Risks: Weak domestic consumption, softer exports, U.S. protectionist measures.
Bearish Scenario (Pessimistic)
- Supporting conditions: Inflation falls below target, BOJ tightens policy too quickly, sharp global slowdown.
- Potential level: Nikkei declines 10–20% to the ¥40,000–¥43,000 range.
- Risks: Global turmoil, deflation, higher borrowing costs, demographic and domestic political challenges.
✍️ Ade Yunus
Global Market Strategies