The Bank of Japan (BOJ) made a bold move on December 19, raising interest rates to their highest level in three decades, sending shockwaves through global markets and impacting the yen's exchange rate. This marks a significant shift in Japan's monetary policy, with domestic and international investors closely monitoring its long-term economic implications.
**End of Ultra-Loose Monetary Policy Era** At its monetary policy meeting on December 19, the BOJ decided to raise its policy rate by 25 basis points, from 0.5% to 0.75%, pushing Japan's interest rates to a 30-year high. In its subsequent policy statement, the central bank indicated that further rate hikes remain possible if economic growth prospects remain stable. When asked about future rate adjustments, BOJ Governor Kazuo Ueda stated, "The pace will depend on economic and price conditions. We will update our outlook and risks at each policy meeting to make appropriate decisions."
This rate hike signals Japan's departure from nearly three decades of ultra-loose monetary policy. Since the collapse of its economic bubble in the early 1990s, the BOJ has maintained ultra-low credit costs to stimulate corporate investment and household spending. Most Japanese banking experts attribute the recent rate hike to the yen's prolonged depreciation. Last month, the yen fell to a 10-month low against the U.S. dollar, nearing the critical 160-yen-per-dollar threshold.
Persistent yen weakness has fueled imported inflation, severely eroding household purchasing power. Japan's core inflation has exceeded the BOJ's 2% target for over three years. Official data released last Friday showed core CPI (excluding fresh food) rose 3% year-on-year in November. The BOJ aims to stabilize inflation around 2% without undermining wage growth, seeking to turn real wage growth positive for sustainable economic expansion.
**Risks of Deepening Economic Slowdown** While the rate hike is seen as a step toward monetary policy normalization, some officials warn it could exacerbate recession risks as Japan struggles to avoid an economic downturn. Rising mortgage and corporate loan rates will further pressure small and medium-sized enterprises (SMEs), already grappling with inflation and labor shortages. NHK reported on December 19 that Tokyo-based SMEs fear significantly heavier financing burdens.
Sanwa Electric, a Tokyo-based precision metal parts manufacturer, saw its operating loan rate jump from 1% to over 2% this month. Despite raising employee wages by 3%-5%, the company faces mounting labor costs and interest expenses, reflecting broader SME struggles. Tightening policy also dampens corporate and consumer spending. The Nikkei Asia noted investors have grown cautious amid rising rates. Daiju Aoki, chief Japan economist at UBS Sumitomo Mitsui Trust Wealth Management, said, "Large firms may weather the storm, but higher rates will hurt SMEs' investment decisions and confidence."
Higher rates also strain household finances. Naoki Hattori, senior economist at Mizuho Research & Technologies, estimates the 0.75% policy rate will add ¥15,000 annually to household income but increase expenses by ¥18,000 for indebted families.
**Yen Remains in Intervention "Danger Zone"** Contrary to expectations, narrowing interest rate differentials have failed to bolster the yen, which remains near historic lows. On December 19, Tokyo forex markets saw the yen hover around ¥155 per dollar initially, but it slid sharply after the BOJ's announcement, hitting ¥157 by evening—reflecting weak market confidence in monetary policy's impact.
Analysts warn that monetary tightening alone cannot pull the yen out of its slump, as Japan faces deep structural imbalances. Nikkei Chinese reports show Japan's trade deficit has persisted for four years, with a ¥1.5 trillion shortfall in the first 10 months of 2025. Dollar-denominated import payments and a ¥5.6 trillion digital services deficit further pressure the yen.
Compounding these challenges, Prime Minister Sanae Takaichi's ¥18.3 trillion stimulus plan—featuring household subsidies and strategic industry investments—has raised fiscal deficit concerns. Growing skepticism about Japan's fiscal discipline suggests a "cautionary sentiment over excessive spending" is spreading. Without addressing structural imbalances, the yen's downtrend may persist.
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