Bank of Japan raises interest rates to highest level since 2008 at 0.5%

The hike is part of the BOJ's plan to gradually increase rates to a neutral level of around 1% to sustain economic stability

The Bank of Japan (BOJ)  raised its short-term policy rate on Friday from 0.25 per cent to 0.5 per cent, marking its highest level in 17 years and the first rate hike since July 2024. The move highlights the BOJ’s confidence in stable inflation around its 2 per cent target, driven by rising wages and a robust economic outlook. Japan’s core inflation rate rose to a 16-month high at 3 per cent in December, year-on-year.

 

The decision was made by Japan’s monetary policy committee with an 8-1 vote. Board member Toyoaki Nakamura was the only one to dissent the decision. The hike is part of the BOJ’s plan to gradually increase rates to a neutral level of around 1 per cent to sustain economic stability.

 

The yen strengthened by 0.5 per cent to 155.32 per dollar following the announcement, while the two-year Japanese government bond (JGB) yield hit 0.705 per cent, its highest since October 2008.

 

Why has Japan's central bank raised interest rates?

 

The BOJ cited rising wages and increasing inflationary pressure as key factors influencing its decision. The central bank noted progress in wage negotiations, with many firms indicating plans to raise wages steadily, bolstering domestic consumption and supporting inflation.

 

“Firms have expressed the view that they will continue to raise wages steadily, following the solid wage increases last year,” the central bank said.

 

In its quarterly outlook report, the BOJ raised its inflation projections, forecasting core consumer inflation to reach 2.4 per cent in fiscal 2025, up from the 1.9 per cent forecast made in October. It also predicted inflation would remain at 2 per cent in 2026. The BOJ noted that risks to inflation were skewed upward, driven by labour shortages, rising prices for staples like rice, and the depreciation of the yen, which has led to higher import costs.

 

Japan's economic growth outlook

 

The BOJ maintained its growth forecast for Japan’s economy, projecting a 1.1 per cent expansion in fiscal 2025 and 1 per cent in 2026. Policymakers emphasised the need to monitor uncertainties in US policy and global financial stability, particularly following recent developments in US economic policy.

 

The BOJ has indicated that further rate hikes are possible if inflation and wage growth remain on track. Analysts, including Matt Simpson of City Index, suggest another 25 basis point hike could occur by the end of 2025, raising rates to 0.75 per cent.