The Bank of Japan (BoJ) raised its benchmark interest rate by a quarter of a percentage point to 1.25% on Friday, pushing borrowing costs to their highest level since 1995. The decision, reached by a seven-to-two vote among board members following a two-day policy meeting, marks the central bank's first rate hike since June and continues its gradual retreat from decades of ultra-low interest rates that had made the yen a widely used cheap funding currency in global markets.
Persistent inflation is driving the move. Core consumer prices in Japan have remained near or above the BoJ's 2% target, sustained by rising energy costs, global supply pressures, and companies continuing to pass higher costs onto consumers across food and grocery items. A structural shift in the labour market is compounding the pressure: Japan's shrinking workforce — the result of a long-running demographic decline — is pushing wages higher in ways that policymakers acknowledge cannot be dismissed as temporary.
External monetary conditions have also weighed on the BoJ's calculus. The US Federal Reserve raised rates on Wednesday, and the prospect of a further hike later this year risks widening the interest rate gap between the United States and Japan. A wider gap tends to weaken the yen, which in turn raises the cost of imports and adds to domestic inflation. The European Central Bank, for its part, has already lifted its key rate to 2.5%, leaving the BoJ's policy rate well below those of its major peers even after Friday's increase.
Markets will now closely watch BoJ Governor Kazuo Ueda's post-meeting press briefing for signals on the pace and timing of future rate increases. The 1.25% rate remains historically low by international standards, but the direction of travel is clear: Japan is steadily unwinding one of the most prolonged experiments in accommodative monetary policy among major economies. How quickly it continues along that path will depend heavily on whether inflation proves durable and whether the yen stabilises in currency markets.