The Bank of Japan has raised its benchmark interest rate to 1%, marking the highest level since 1995 and signalling a continued shift away from decades of ultra-loose monetary policy. The widely anticipated decision increases short-term borrowing costs from 0.75% and represents the central bank’s first rate hike since December, as policymakers respond to persistent inflationary pressures and a weakening yen.

The move comes as part of the Bank of Japan’s broader policy normalisation process that began in March 2024, when it delivered its first interest rate increase in 17 years. After years of maintaining near-zero or negative interest rates to stimulate growth, the central bank is now gradually tightening policy in response to evolving global and domestic economic conditions.

Officials have pointed to rising energy costs and currency weakness as key factors influencing the decision. While consumer inflation remains below the bank’s 2% target, higher import costs driven by a weaker yen have raised concerns about broader and more sustained price increases across the economy. The central bank noted that risks from global geopolitical tensions, including conflict in the Middle East, have eased due to government measures aimed at stabilising fuel prices.

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At the same time, the bank warned that companies are increasingly passing on higher input costs to consumers, particularly through business-to-business transactions. Japan’s producer price index rose 6.3% in May compared to a year earlier, marking the fastest increase in more than three years and reflecting the impact of elevated energy prices on corporate costs.

Consumer inflation, however, has remained relatively subdued, with both headline and core inflation recorded at 1.4% in April. The Bank of Japan said government subsidies and support measures for household energy bills have helped contain price growth, even as underlying cost pressures continue to build in the economy.

The decision was approved by a 7-1 vote, with one board member dissenting in favour of maintaining rates at 0.75%. Alongside the rate hike, the central bank confirmed it will continue reducing government bond purchases in a phased manner, as it gradually unwinds long-standing monetary easing policies that defined Japan’s economic strategy for decades.

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