The Bank of Japan raised its short-term policy rate to 1% on Tuesday, lifting borrowing costs to their highest level since 1995 in a widely expected move aimed at containing broadening inflationary pressures from the energy shock caused by the Iran conflict.

Key Highlights

  • The BOJ raised its policy rate to 1% from 0.75%, the highest level since 1995.
  • The decision was made by a 7-1 vote, with dovish newcomer Toichiro Asada the sole dissenter.
  • Japan's wholesale inflation spiked to a three-year high of 6.3% in May as companies passed on energy costs.
  • The BOJ decided to pause its bond taper programme from April 2027, continuing to buy roughly 2 trillion yen in JGBs per month.

The Bank of Japan raised its short-term policy rate by 25 basis points to 1% on Tuesday, marking its first rate increase since December and pushing borrowing costs to levels not seen since 1995. The move aligns the BOJ with other major central banks that have shifted toward tighter monetary policy in response to energy-driven inflation, including the European Central Bank, which raised rates earlier this month for the first time since 2023.

The decision was made by a 7-1 vote, with Toichiro Asada, who joined the BOJ board in April as the first member hand-picked by dovish Prime Minister Sanae Takaichi, the sole dissenter. Asada argued that downside risks to growth from the Middle East conflict outweighed the inflation risks, reflecting a more cautious view on the economic outlook.

Governor Kazuo Ueda was absent from the meeting for medical treatment, with Deputy Governor Shinichi Uchida representing the board at the post-meeting press conference. Uchida acknowledged the recent peace agreement between the United States and Iran, describing it as a welcome development, but noted that inflationary risks persist and that price increases are broadening across the economy.

The BOJ said in its statement that the risk of Japan's economy deteriorating sharply from the Middle East conflict has diminished, citing progress in procuring alternative energy supplies. However, the central bank flagged that companies were passing on higher oil costs to one another at a relatively fast pace, with the potential to push up consumer prices across a wide range of goods.

Japan's wholesale inflation spiked to a three-year high of 6.3% in May, a sign that cost pressures from the energy shock were already moving through supply chains. Analysts expect core consumer inflation to accelerate back above the BOJ's 2% target later in the year, after sliding below that level on the back of government subsidies designed to curb utility bills.

The yen fell briefly after the announcement before sliding to around 160.29 per dollar, hovering near a level seen as increasing the risk of currency intervention by Japanese authorities. A weak yen tends to amplify imported inflation, keeping pressure on the BOJ to continue raising rates gradually. The Nikkei 225 jumped as much as 1% following the decision, briefly setting a fresh record above 70,000.

On bond purchases, the BOJ decided to pause its bond taper programme from April 2027, continuing to buy approximately 2 trillion yen, or around $12.5 billion, in Japanese government bonds per month. The central bank said it would discontinue its practice of conducting annual reviews of the bond taper plan, while retaining the flexibility to adjust the pace of purchases at future policy meetings if conditions warrant.

Market participants noted that the absence of a 50 basis point rate hike proposal is positive for risk assets, as it suggests the BOJ is likely to continue raising rates at a measured pace of roughly once every six to twelve months.

The BOJ's move comes ahead of the US Federal Reserve's policy decision on Wednesday, where the central bank is widely expected to hold rates steady but has recently signaled rising concern about inflation, with market pricing increasingly tilting toward a Fed hike as the next move rather than a cut.