Japan raises interest rate to highest since 1995

Japan's central bank has increased its main interest rate to a new 31-year high after a surge in global energy prices.

On Tuesday, the Bank of Japan (BOJ) raised its so-called policy rate to 1% from 0.75% - a level not seen since 1995.

The decision comes as some other central banks have raised interest rates this year as the US-Israel war with Iran pushed up the cost of living.

Japan's interest rates were cut aggressively in the 1990s to combat the fallout from a collapse in prices of assets like property and shares. They had been near zero for two decades as prices fell and growth stagnated.

The bank has been gradually raising its interest rate since March 2024 - at the time it was the country's first hike in 17 years.

"After twenty years of deflation, Japan is now in an inflationary upcycle," Japan economist Jesper Koll told the BBC.

"Emergency/crisis management monetary policy is no longer needed and the BOJ wants to get back to a normal monetary policy," he added.

The BOJ has been under pressure to cool inflation, which was extremely low in the country until relatively recently.

Higher energy prices have fuelled inflation, adding pressure on countries like Japan that depend heavily on oil and gas from the Middle East.

Japan's wholesale prices climbed by more than 6% in May from a year earlier, rising at the fastest pace in three years.

But the country's overall inflation rate, which was 1.4% in April, currently sits below the BOJ's target level of 2%.

The risk of Japan's economy deteriorating sharply due to the Iran war is less likely beacause of government measures including easing the impact on households from high fuel costs, the bank said on Tuesday.

But it added: "Taking into account that medium- and long-term inflation expectations have also continued to increase, there is a risk of underlying inflation deviating above our price target."

The BOJ faces a tricky trade-off: Raising interest rates could help lower inflation but higher rates also make borrowing costlier, increasing expenses for the government and businesses.

The bank's governor Kazuo Ueda - a central figure in deciding interest rates - missed this week's meeting due to being in hospital as he is treated for an infected liver cyst.

But, along with other BOJ policymakers, he has expressed an increasingly positive stance on raising rates in recent months.

"Even if the situation remains unclear, should it be judged that upside risks to prices outweigh downside risks to economic activity, it will be necessary to thoroughly discuss the pros and cons of raising the policy interest rate," Ueda earlier this month.

Prime Minister Sanae Takaichi, known for her support of boosting spending in the country, has previously dismissed the idea of hiking interest rates, though she is under pressure to bring down Japan's inflation.

However, she has not publicly criticised the BOJ's push for higher rates since taking office last year.

The latest rate rise is the second since Takaichi took office, and had been expected since the BOJ raised its policy rate to "around 0.75%" in December.

The decision to raise rates also comes as the bank aims to stabilise the yen, which has come under pressure from other major currencies like the US dollar and the euro.

"There has been a sense that the yen is too cheap and that raising its currency will not hurt," said University of California San Diego business professor Ulrike Schaede.

Even with the hike, Japan's interest rate remains low compared to other big economies.

The US and UK, for example, currently have interest rates of above 3%, although both central banks are expected to keep their rates on hold when they meet this week.

Meanwhile, the Reserve Bank of Australia held rates at 4.35% on Tuesday but said it may hike again if needed to control inflation.

But what we are seeing could signal "a slow global realignment," Schaede said.

Additional reporting by Osmond Chia