The Bank of Japan (BOJ) raised interest rates to their highest level in 31 years on Tuesday, marking another major step in its effort to normalise monetary policy as inflation pressures increase following an energy shock linked to the Iran war. The decision raises Japan’s short-term policy rate from 0.75% to 1%, the highest level since 1995.
The move, which was widely expected, represents the BOJ’s first rate increase since December and places Japan among major central banks moving toward tighter monetary policy to contain inflation. The European Central Bank and other institutions have also shifted their approaches as price pressures remain elevated.
According to Reuters, Deputy Governor Shinichi Uchida said the recent US-Iran peace agreement was a positive development but warned that inflation risks remained. Uchida spoke on behalf of Governor Kazuo Ueda, who was absent from the meeting while receiving medical treatment.
“Compared with the previous meeting, the risk of a sharp deterioration in the economy has diminished,” Uchida said. He added that price increases were becoming broader and that underlying inflation could move away from the BOJ’s target.
The BOJ said the risk of a severe economic downturn caused by the Middle East conflict had declined because Japan had made progress in securing alternative energy supplies. However, the central bank said inflation remained a concern as companies were passing higher oil costs through supply chains at a relatively fast pace, potentially increasing consumer prices across a wide range of goods.
The decision was approved by a 7-1 vote. Toichiro Asada, who joined the BOJ board in April and was selected by Prime Minister Sanae Takaichi, opposed the increase. Asada argued that economic risks from the Middle East conflict outweighed inflation concerns.
Market analysts said the decision suggested the BOJ was likely to continue increasing rates gradually rather than pursuing aggressive tightening. Hirofumi Suzuki, chief foreign exchange strategist at SMBC, said the absence of a proposal for a larger 50-basis-point increase indicated that sharp rate hikes were unlikely.
Following the announcement, Japan’s Nikkei 225 index rose as much as 1%, reaching a record high above 70,000 points. The yen initially strengthened before weakening to around 160.29 against the US dollar, a level that has increased expectations of possible currency market intervention.
The BOJ also announced changes to its bond-buying strategy. The central bank decided to pause its bond tapering programme from April 2027 and continue purchasing approximately 2 trillion yen ($12.5 billion) worth of Japanese government bonds each month. It will stop conducting annual reviews of its bond taper plan but said it could adjust purchases if economic conditions require changes.
The rate increase comes as the BOJ faces a difficult policy environment. The conflict in the Middle East has increased energy costs for Japan, an economy heavily dependent on imported fuel. Although the US-Iran peace agreement reduced some concerns about global inflation pressures, wholesale inflation in Japan reached a three-year high of 6.3% in May, showing that businesses were already passing higher energy costs on to customers.
Analysts expect core consumer inflation to rise above the BOJ’s 2% target later this year after temporarily falling below that level due to government subsidies aimed at reducing utility costs. A weaker yen has also increased pressure on the central bank because it raises import costs and contributes to inflation.
The BOJ’s decision comes during a busy period for global central banks. The US Federal Reserve is widely expected to keep its benchmark interest rate unchanged, although officials have recently expressed increased concern about inflation. Market expectations have shifted toward the possibility of future rate increases rather than cuts.
The BOJ’s latest move signals continued efforts to move away from years of ultra-low interest rates while managing the risks posed by rising prices and uncertainty in global energy markets.
