Bank of Japan raises key rate to 31-year high of 1.25%

The Bank of Japan (BOJ) has raised its main interest rate to 1.25%. This marks a fresh 31-year high, a level last seen in 1995, as the central bank moves decisively away from its long-held ultra-low rate policy.

According to the BBC, the widely expected hike on Friday increased the rate from 1%. The BOJ has now raised rates six times over the past two and a half years, beginning in 2024 when the rate stood at minus 0.1%. The bank's actions are part of a broader global trend of monetary tightening.

Global context of rate hikes

Major central banks worldwide are increasing borrowing costs. Higher energy prices, fueled by the Iran war, are contributing to inflationary pressures. Earlier this week, the US Federal Reserve raised its benchmark rate for the first time in over three years. The European Central Bank also increased its borrowing costs earlier this month. The BOJ aims to bring its rate to a level more comparable with these other major economies.

A central bank rate hike typically strengthens a nation's currency by making it more attractive to foreign investors. Japan faces significant economic headwinds, including a persistently weak yen, rising consumer prices, and a shrinking workforce.

Inflation and economic pressures

Official data released on Friday showed a slight easing in price pressures. Core inflation fell to 1.7% in August from 1.8% in July. This figure remains close to the bank's 2% target. For Japan, rising prices represent a relatively new challenge. The country had experienced very low inflation or outright deflation for roughly three decades prior to the recent shift.

The global surge in oil and gas prices is a key driver. Disruptions to shipments through the Strait of Hormuz, caused by the Iran war, have been a major factor. Japan is particularly vulnerable to such supply shocks due to its heavy reliance on energy imports from the Middle East.

The weak yen and international pressure

The Japanese currency has faced intense pressure in recent months. In August, the yen fell to a fresh 40-year low. This prompted Tokyo and Washington to confirm a joint intervention in the foreign exchange market to halt the slide. It was the first such coordinated action since 2011, when both nations acted together to weaken the yen following a devastating earthquake and tsunami.

Both Japan's Ministry of Finance and US Treasury Secretary Scott Bessent stated they would not hesitate to conduct more joint interventions if necessary. Bessent has also publicly pressured the BOJ to raise interest rates to help support the yen. He called on BOJ Governor Kazuo Ueda to, in his words, "do the right thing." The latest rate increase can be seen as a direct response to these domestic and international economic pressures.