The Bank of Japan raised its benchmark interest rate to 1% on Tuesday, lifting borrowing costs to their highest level since 1995 as policymakers sought to contain inflationary pressures linked to higher energy prices and support the yen.
The widely expected move increased the central bank's short-term policy rate from 0.75% and marked its first rate rise since December. It also extended the policy normalisation process that began in March 2024, when the Bank of Japan delivered its first interest rate increase in 17 years after decades of ultra-loose monetary policy.
The decision underscores the challenge facing Japan's central bank as it balances the need to contain price pressures against the risk that higher borrowing costs could weigh on businesses, households and public finances. While consumer inflation remains below the Bank of Japan's 2% target, rising energy costs and a weaker yen have heightened concerns that broader price increases could take hold.
Energy Prices, Inflation In Focus
In a statement accompanying the decision, the Bank of Japan said risks of a sharp deterioration in the economy stemming from conflict in the Middle East had eased, citing government measures to reduce the burden of higher fuel costs on households and progress in securing alternative energy supplies.
At the same time, it warned that companies were passing on higher oil costs at a "relatively fast pace" through business transactions, raising the prospect of broader increases in consumer prices.
"However, the price pass-through stemming from the rise in crude oil prices has been progressing at a relatively fast pace in business-to-business transactions, which could spread to an increase in consumer prices across a wide range of items," the central bank said.
Japan's producer price index rose 6.3% in May from a year earlier, recording its fastest increase in more than three years, driven largely by higher energy costs.
Consumer inflation has remained more subdued. Headline inflation and core inflation both stood at 1.4% in April, marking a fourth consecutive month below the Bank of Japan's 2% target. The central bank said government support measures aimed at easing households' energy bills had helped restrain consumer prices.
Yen Weakness Adds Pressure
The weakness of the yen also strengthened the case for tighter policy.
Although a weaker currency can improve the competitiveness of Japanese exports, it raises the cost of imports and can add to inflation in an economy heavily dependent on energy supplies from overseas.
The Bank of Japan said it would continue reducing its purchases of government bonds by 200 billion yen each quarter before maintaining monthly Japanese government bond purchases of 2 trillion yen from April 2027.
The rate decision was approved by a 7-1 vote, with board member Toichiro Asada dissenting and arguing for rates to remain unchanged at 0.75%.
Governor Kazuo Ueda did not attend this week's policy meeting because he was in hospital receiving treatment for an infected liver cyst. In recent months, however, he and other policymakers had signalled a greater willingness to raise interest rates.
Japan cut interest rates aggressively during the 1990s after the collapse of asset prices, including property and equities. Rates remained near zero for much of the following two decades as the country grappled with weak growth and persistent low inflation.
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