The Bank of Japan has pushed its main interest rate to a 31-year high of 1%, a move driven by the surge in global energy prices triggered by the US-Israel war with Iran. The increase from 0.75% marks the highest policy rate since 1995, as the central bank tries to cool an economy that has finally escaped two decades of deflation.
Japan's interest rates had been slashed in the 1990s after a collapse in asset prices, and they lingered near zero for twenty years as prices fell and growth stagnated. But in March 2024, the BOJ raised rates for the first time in 17 years, beginning a gradual tightening cycle that culminated in Tuesday's decision.
“Bank of Japan raises main interest rate to 1%, highest since 1995, amid energy price surge.”
"After twenty years of deflation, Japan is now in an inflationary upcycle," said Japan economist Jesper Koll. "Emergency/crisis management monetary policy is no longer needed and the BOJ wants to get back to a normal monetary policy."
The bank has been under mounting pressure to rein in inflation, which was virtually non-existent in Japan until recently. Higher energy prices have fuelled the rise, particularly for a country heavily dependent on Middle East oil and gas. Japan's wholesale prices surged more than 6% in May from a year earlier, the fastest pace in three years. Overall inflation, however, stood at 1.4% in April, still below the BOJ's 2% target.
The BOJ acknowledged the risk of an economic downturn due to the Iran war but said government measures to ease fuel costs for households made a sharp deterioration less likely. It warned that "medium- and long-term inflation expectations have also continued to increase" and that there was "a risk of underlying inflation deviating above our price target."
The central bank faces a difficult calculation: raising rates could help bring down inflation but also makes borrowing more expensive for the government and businesses. Governor Kazuo Ueda, who missed this week's meeting because he is being treated in hospital for an infected liver cyst, has previously signalled his readiness to hike. "Even if the situation remains unclear, should it be judged that upside risks to prices outweigh downside risks to economic activity, it will be necessary to thoroughly discuss the pros and cons of raising the policy interest rate," Ueda said earlier this month.
Prime Minister Sanae Takaichi, known for her support of boosting spending, has previously dismissed the idea of raising rates, but she now faces growing pressure to curb inflation.