Bank of Japan Raises Interest Rate to 1.25%, Highest Since 1995, as Inflation Risks Mount

The Bank of Japan (BOJ) has raised its policy interest rate by 25 basis points to 1.25%, taking borrowing costs to their highest level since 1995 as the central bank steps up efforts to contain inflation and support the yen.

The decision, announced after the BOJ's latest policy meeting, marks a faster pace of monetary tightening since Japan began normalising its ultra-loose monetary policy in March 2024. The latest hike came just three months after the previous increase, compared with a six-month gap between the earlier moves.

BOJ vote split 7-2

The rate increase was approved by a 7-2 majority.

BOJ board members Toichiro Asada and Ayano Sato opposed the hike, arguing that current economic and price developments did not warrant an immediate increase.

Both were appointed earlier this year by Prime Minister Sanae Takaichi and are regarded as favouring policies aimed at supporting reflation.

Asada said core inflation remained below the BOJ's 2% target and suggested that the underlying economic situation may not be strong enough to justify another rate increase. He instead backed keeping rates unchanged.

Sato similarly said economic and price developments had not accelerated substantially compared with the situation before the latest decision.

Inflation risks prompt rate hike

The BOJ said the increase was driven by the risk that inflation could move above its 2% target.

The central bank said it wants underlying inflation to stabilise at around 2%, arguing that a sustained overshoot could eventually have an adverse impact on Japan's economy.

The decision had been widely anticipated. Nearly 90% of economists surveyed by CNBC had expected a 25-basis-point increase, while respondents also anticipated the two dissenting votes.

Core inflation remains below 2%

Japan's latest inflation data showed headline inflation at 1.9% in August.

Core inflation, which excludes fresh food prices, stood at 1.7%, easing from 1.8% in July.

The inflation figures have added to pressure on the BOJ as it balances the need to prevent prices from rising too quickly against concerns over the strength of domestic economic activity.

Yen remains under pressure

The rate increase comes as the Japanese yen remains historically weak.

The currency traded at 156.64 against the US dollar following the BOJ's decision, weakening by 0.45%.

Meanwhile, the benchmark 10-year Japanese government bond yield fell 4.9 basis points to 2.947%.

The yen's weakness has increased the cost of imported goods and energy, adding another consideration for policymakers as they assess the outlook for inflation.

US pressure adds to policy debate

The BOJ's tightening cycle has also attracted attention from Washington, with US officials calling for Japan to continue moving towards higher interest rates.

US Treasury Secretary Scott Bessent recently urged BOJ Governor Kazuo Ueda to take "decisive market and monetary steps" during the G20 finance ministers and central bank governors meeting earlier this month.

The pressure comes as Takaichi's government has favoured an easier monetary policy alongside an expansionary fiscal approach, creating a policy debate over the pace at which Japan should continue normalising interest rates.

The latest BOJ decision signals a further step away from Japan's long-running era of ultra-low interest rates, while the central bank continues to weigh inflation, economic growth and currency pressures.