The Bank of Japan has raised its benchmark interest rate to 0.75%, the highest level in three decades, in a decisive move to tackle persistent inflation that has been eroding household incomes and challenging economic stability. This rate hike, implemented on Friday, marks a significant shift in monetary policy as Japan grapples with cost-of-living pressures amid a weak currency and high import costs.
In a widely anticipated decision, the BOJ increased its short-term policy rate by 25 basis points, bringing it to around 0.75% for the first time since 1995. The move was led by Governor Kazuo Ueda and comes under the administration of Prime Minister Sanae Takaichi, who has recently made inflation control a priority despite earlier opposition to rate hikes. This is the first rate increase since January and the first since both Ueda and Takaichi assumed their current roles, highlighting a coordinated effort to address economic challenges.
Inflation has remained a stubborn issue in Japan, with consumer prices excluding food and fuel rising by 3% in November, above the BOJ’s 2% target for the 44th consecutive month. The weak yen, which has been trading around 155 to the dollar, has exacerbated the situation by increasing the cost of imports, thereby fueling inflation. The rate hike aims to strengthen the yen and ease inflationary pressures, though economists note that the impact may be limited as markets have largely priced in the move.
The economic backdrop is concerning, with revised GDP data showing a contraction of 0.6% in the third quarter, or 2.3% on an annualized basis. Japan’s debt-to-GDP ratio, the highest in the world at nearly 230%, adds fiscal strain, as higher interest rates could increase government borrowing costs. However, the BOJ emphasized that real interest rates are expected to remain significantly negative, and accommodative financial conditions will continue to support economic activity.
Financial markets reacted swiftly to the decision, with the yield on 10-year Japanese government bonds breaching the 2% mark for the first time since 1999, indicating a sell-off in bonds. The yen weakened slightly to 155.92 against the dollar, while the Nikkei 225 stock index gained over 1%. These movements reflect investor uncertainty about the pace of future rate hikes and their impact on Japan’s economy.
Prime Minister Takaichi’s stance has evolved from labeling rate hikes as “stupid” during her leadership campaign to accepting them as necessary to address the cost-of-living crisis. Her administration approved a 21.3 trillion yen stimulus package in November to support consumers and boost the slowing economy. This shift underscores the political pressure to curb inflation, which has eroded support for her ruling Liberal Democratic Party.
Looking ahead, the BOJ signaled its readiness for further tightening, with economists projecting another rate hike in mid-2026 to reach a terminal rate of 1%. The central bank expects core inflation to decelerate below 2% by April to September 2026, due to slower food price rises and government measures. However, Governor Ueda noted that estimating the neutral rate remains challenging, with a range of 1% to 2.5%.
Globally, Japan’s rate hike contrasts with the easing policies of other major central banks, such as the Federal Reserve and Bank of England, which have recently cut rates. This divergence highlights Japan’s unique economic predicament and its gradual exit from decades of ultra-loose monetary policy. As the BOJ monitors the effects of this hike, the focus will be on balancing inflation control with economic growth, setting the stage for cautious policy moves in the coming months.
