The Bank of Japan has increased its short-term policy interest rate to approximately 1%. This move pushes Japanese borrowing costs to their highest level in 31 years amid persistent domestic inflation.
The rate hike of 25 basis points aligns with widespread market expectations. Analysts note that following years of ultra-low interest rates and deflation, this marks a crucial milestone in the central bank's journey toward normalizing monetary policy.
The last instance the BoJ's policy rate was at 1% dates back to 1995. At that time, Japan was in a rate-cutting cycle following the collapse of the asset bubble from the late 1980s.
In a statement accompanying the decision, the Bank of Japan indicated it will continue advancing monetary policy normalization. It will adjust the policy rate as appropriate, considering economic activity, price trends, and changes in financial conditions, while scaling back monetary easing.
The central bank also announced that starting from April 2027, it will cease reducing its monthly Japanese government bond purchases, stabilizing the buying amount at around 2 trillion yen per month. This measure was also widely anticipated by the market.
Following the announcement, the USD/JPY exchange rate held steady around 160.2 yen per dollar. The Nikkei 225 index briefly surpassed the 70,000-point mark, setting a new all-time high, before retracing some gains.
The Bank of Japan stated that while rising crude oil prices are weighing on economic activity, "the risk of a significant economic slowdown has decreased compared to before."
The central bank further noted that cost pass-through from fuel price increases is relatively swift, and price pressures may spread from business-to-business transactions outward, potentially pushing the core consumer inflation rate above the 2% policy target.
Having exited the negative interest rate era in 2024, the Bank of Japan has now completed two rate hikes in 2025. Markets had broadly expected the bank to settle into a pattern of gradual tightening approximately every six months. Some economists believe another 25-basis-point hike could occur as soon as October this year.
This week's rate decision was passed by the central bank's policy board with a vote of 7 in favor and 1 against. Governor Kazuo Ueda was hospitalized last week, reducing the current number of board members to eight.
The dissenting board member, Hajime Takata, argued that the downside risks to Japanese production and employment from the Middle East situation outweigh the upside risks to prices.
"The vote is noteworthy as it reflects a more balanced view within the board, which had previously been clearly skewed hawkish," said Stefan Angrick, Senior Economist for Japan at Moody's Analytics.
He added, "In reality, the Bank of Japan is now caught between a rock and a hard place, with no optimal choice. Raising rates can support the yen and curb inflation pressures, but it will also hit the economy."
Governor Kazuo Ueda, who is receiving treatment for a liver condition, did not attend this policy meeting and did not vote. He is expected to return for the July policy meeting. This week's meeting was chaired by Deputy Governor Ryozo Himino.
A press conference in the afternoon will be led by another Deputy Governor, Shinichi Uchida. Markets will scrutinize his remarks for signals on how the central bank will continue assessing the negative economic impact of the Iran conflict.
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