The Bank of Japan (BoJ) raised its benchmark interest rate by a quarter of a percentage point to 1 percent on Tuesday, June 16, reaching its highest level since 1995 — a 31-year high. The decision, widely anticipated by markets, marks the first rate increase since December and reflects growing concern that surging oil prices and a weakening yen could push inflation well above the central bank's 2 percent target.

The primary driver behind the move is the ongoing conflict in the Middle East, which has sent global oil prices soaring. Japan is particularly exposed: before the war began in late February, the country relied on the Middle East for around 90 percent of its crude oil supplies, and it imports almost all of its energy needs. Though the United States and Iran have agreed to a peace deal and the reopening of the Strait of Hormuz — the critical waterway through which roughly a fifth of the world's oil previously passed — trade flows are expected to take considerable time to normalise. The BoJ noted that while higher crude prices have weighed on economic activity, corporate profits and employment conditions have provided some support. However, it warned that rising costs in business-to-business transactions risk spreading more broadly to consumer prices.

Japan's difficulties have been compounded by a weakening yen, which has hovered at around 160 to the US dollar. The currency's slide is partly a consequence of the large gap between Japanese interest rates — among the lowest in the developed world — and those elsewhere. The government spent approximately 11.7 trillion yen (around US$72 billion) last month in currency intervention to support the yen. The rate hike briefly pushed the yen higher against the dollar. Meanwhile, the Nikkei 225 stock index rose above 70,000 points for the first time ever before paring some gains, closing up around 0.8 percent.

The decision fits into a broader global pattern of monetary tightening prompted by the conflict. The European Central Bank and Bank Indonesia both raised rates last week for similar reasons, and expectations are building that the US Federal Reserve may follow, with American inflation at a three-year high. The BoJ indicated it intends to continue raising rates gradually, while carefully monitoring the evolving situation in the Middle East.

Governor Kazuo Ueda, who has been hospitalised, was absent from Tuesday's policy board meeting. Deputy Governor Shinichi Uchida was set to hold the post-decision press conference in his place. The decision was not unanimous — one board member voted against the hike — reflecting internal tension between market pressure to tighten policy further and concerns from the government about the potential drag on economic growth from higher borrowing costs.