Japan raises rates to highest since 1995 as BOJ steps up battle against inflation – Firstpost

Japan’s central bank on Tuesday raised its benchmark interest rate to 1 per cent, the highest level in more than three decades, as policymakers intensified efforts to contain inflationary pressures fuelled by soaring energy costs and a weak yen.

The Bank of Japan (BOJ) increased its short-term policy rate from 0.75 per cent, marking its first rate hike since December and taking borrowing costs to their highest level since 1995. The move was widely expected by economists and represents another major step in the central bank’s gradual exit from decades of ultra-loose monetary policy.

The decision was approved by a 7-1 vote, with board member Toichiro Asada dissenting and arguing for maintaining the current rate.

The latest tightening comes as Japan grapples with rising import costs linked to higher global energy prices following the Iran war, which has added inflationary pressures across major economies and prompted several central banks to maintain or adopt tighter monetary policies.

“The Bank judges that upside risks to prices warrant continued policy normalisation,” the BOJ said in its statement, underscoring concerns that rising energy and import costs could push inflation higher in the coming months.

Inflation concerns drive policy shift

The rate increase highlights the dramatic transformation of Japan’s economic landscape after years of battling deflation and weak domestic demand.

For much of the past two decades, the BOJ kept interest rates near zero and deployed unconventional stimulus measures to revive growth and lift inflation. In March 2024, it delivered its first rate increase in 17 years, ending the world’s last negative interest-rate regime.

Since then, policymakers have gradually tightened policy as inflationary pressures strengthened.

Japan’s wholesale inflation accelerated to 6.3 per cent in May, the fastest pace in three years, driven largely by higher fuel and commodity costs. While consumer inflation has remained below the BOJ’s 2 per cent target, policymakers have become increasingly concerned that sustained increases in producer prices could eventually feed into broader inflation.

Core consumer inflation eased to 1.4 per cent in April, remaining below target for a fourth consecutive month. However, analysts say government subsidies and temporary policy measures have masked underlying price pressures.

Weak yen adds urgency

Pressure on the Japanese currency also played a role in the BOJ’s decision.

The yen has remained near multi-decade lows against the US dollar despite large-scale government intervention. Authorities reportedly spent 11.7 trillion yen (about $73.5 billion) in May to support the currency, but the yen continued to hover around the 160-per-dollar level.

A weaker currency has helped Japan’s exporters remain competitive abroad but has simultaneously increased the cost of imported fuel, food and raw materials, squeezing household budgets and adding to inflation.

The BOJ has repeatedly indicated that exchange-rate developments will remain an important factor in its policy deliberations given their impact on import prices and inflation expectations.

Ueda absent from key meeting

The policy meeting took place without BOJ Governor Kazuo Ueda, who is undergoing treatment in hospital for an infected liver cyst and is expected to be absent for about two weeks.

Deputy Governor Shinichi Uchida is scheduled to brief the media on the decision and the central bank’s outlook.

Before the meeting, Ueda had signalled a growing willingness to tighten policy, saying policymakers would need to consider additional rate increases if inflation risks continued to outweigh risks to economic activity.

His comments, along with the BOJ’s upward revisions to inflation forecasts at its April meeting, had led markets to fully price in Tuesday’s rate hike.

Balancing inflation and growth

Despite the increase, Japan’s policy rate remains among the lowest in the developed world. Benchmark rates in the United States and Britain remain above 3 per cent, although both central banks are expected to keep rates unchanged at their upcoming meetings.

Analysts say the BOJ faces a delicate balancing act. Higher interest rates could help contain inflation and stabilise the yen, but they also risk slowing economic growth and increasing borrowing costs for businesses and households.

The challenge is particularly significant for Japan’s heavily indebted government, which faces higher debt-servicing costs as rates rise.

Prime Minister Sanae Takaichi’s administration has already introduced a supplementary budget worth 3 trillion yen to cushion households from rising energy prices. While Takaichi has historically favoured loose fiscal and monetary policy, she has largely refrained from publicly criticising the BOJ’s tightening cycle since taking office last year.

More hikes expected

Financial markets are now focused on whether the BOJ will continue raising rates later this year.

A Reuters poll showed economists expect the central bank to lift rates again to 1.25 per cent in the fourth quarter, although uncertainty surrounding global energy prices and geopolitical developments could affect the pace of future tightening.

Some analysts believe a recent peace agreement between the United States and Iran could ease oil prices and reduce inflationary pressures, potentially giving the BOJ greater flexibility in future policy decisions.

Even so, Tuesday’s move underscores the BOJ’s determination to continue normalising policy after years of extraordinary stimulus.

With rates now at their highest level since 1995, Japan’s central bank has signalled that its long battle against deflation is giving way to a new challenge: preventing inflation from becoming entrenched while preserving economic growth.