Japan’s central bank has pushed its main interest rate to the highest level in 31 years, a dramatic shift for a country that kept borrowing costs near zero for two decades. On Tuesday, the Bank of Japan (BOJ) raised its policy rate to 1% from 0.75% – a level not seen since 1995. The move comes as global energy prices have surged, partly due to the US-Israel war with Iran, fuelling inflation in resource-poor Japan.
The BOJ’s decision marks the latest step in a gradual tightening cycle that began in March 2024, when it raised rates for the first time in 17 years. For years, Japan’s economy was trapped in deflation – falling prices that discouraged spending and investment. To fight this, the BOJ slashed rates in the 1990s after a collapse in asset prices, and they stayed near zero for roughly two decades. Now, the country is experiencing an “inflationary upcycle”, according to 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,” he told the BBC.
“An explainer on why Japan raised interest rates to a 31-year high and what it means for the UK.”
Higher energy prices have been a key driver. Japan depends heavily on oil and gas imports from the Middle East, and wholesale prices climbed more than 6% in May from a year earlier – the fastest pace in three years. However, the overall inflation rate stood at just 1.4% in April, below the BOJ’s 2% target. The bank faces a tricky trade-off: raising rates can help cool inflation, but it also makes borrowing more expensive for the government and businesses. The BOJ acknowledged that government measures to ease fuel costs reduce the risk of a sharp economic downturn, but warned that “medium- and long-term inflation expectations have also continued to increase, there is a risk of underlying inflation deviating above our price target”.
For UK readers, Japan’s rate rise matters because it signals a global shift away from ultra-loose monetary policy. Many central banks, including the Bank of England, have been raising rates to combat inflation, but Japan was a notable holdout. As Japan normalises policy, it could affect global bond yields and investment flows. More directly, if Japan’s rates continue to rise, the yen may strengthen, making UK exports to Japan cheaper but Japanese goods more expensive. However, the BOJ’s cautious approach – it has only raised rates gradually – means any impact on ordinary UK consumers is likely to be muted in the short term.
Q: Why did Japan keep interest rates so low for so long? Japan experienced deflation and stagnant growth after a massive asset price bubble burst in the early 1990s. To revive the economy, the central bank cut rates to near zero, and they stayed there for roughly 20 years as prices fell and growth was weak.
Q: What is the BOJ’s current inflation target? The Bank of Japan has a target of 2% inflation. As of April, Japan’s annual inflation rate was 1.4%, below that target. However, the bank is worried that rising energy costs and inflation expectations could push prices above target in the medium term.
Q: Who is Kazuo Ueda, and why is he important? Kazuo Ueda is the governor of the Bank of Japan and the key figure in deciding interest rate policy. He missed the recent meeting due to being treated for an infected liver cyst, but has previously expressed support for raising rates if upside risks to prices outweigh downside risks to economic activity.
What happens next? The BOJ has signalled it will keep raising rates if inflation continues to rise, but it must balance that against the risk of hurting economic growth. Prime Minister Sanae Takaichi, who has previously opposed rate hikes, faces pressure to bring down living costs. The bank’s next moves will depend on how energy prices, the Iran conflict, and domestic demand evolve in the coming months.