Bank of Japan raises interest rate to 1.25 per cent in fastest tightening cycle since 1990

The Bank of Japan has raised its benchmark interest rate to 1.25 per cent, its highest level in 31 years, as policymakers accelerate their retreat from decades of ultra-cheap money.

The quarter-point increase from 1 per cent on Friday marks the fastest pace of monetary tightening Japan has seen since 1990. It is the sixth interest rate hike in two and a half years, representing a dramatic turnaround from early 2024, when the central bank's key rate still sat in negative territory at minus 0.1 per cent.

Japan's central bank has been steadily raising borrowing costs to bring its monetary policy in line with other major economies. Higher rates typically strengthen a currency by making domestic assets more attractive to international investors, a mechanism Tokyo is eager to trigger to halt a long-term slide in the yen.

Why borrowing costs are rising

The decision comes amid intense pressure on the currency and rising import costs. Global oil and gas prices have surged this year due to shipping disruptions in the Strait of Hormuz caused by the war involving Iran. Japan is exceptionally vulnerable to these supply shocks because it relies almost entirely on the Middle East for its fuel imports.

These energy pressures have fed directly into domestic prices. Economic data published on Friday morning, shortly before the central bank's announcement, showed that core inflation fell slightly to 1.7 per cent in August from 1.8 per cent in July.

While that remains below the high inflation rates seen in Europe and the US, it is close to the central bank’s 2 per cent target. For a nation that spent nearly thirty years battling deflation and falling prices, even mild inflation represents a significant structural change.

Pressure on the yen

Currency markets have also forced policymakers' hands. In August, Tokyo and Washington launched a joint market intervention to prop up the Japanese currency after it plunged to a fresh 40-year low. It was the first time the two nations had coordinated such an action since the aftermath of the 2011 earthquake and tsunami.

Both the Japanese Ministry of Finance and US Treasury Secretary Scott Bessent warned at the time that they would not hesitate to intervene again if necessary. Bessent has since stepped up pressure on central bank governor Kazuo Ueda to lift rates, calling on him to "do the right thing" to defend the currency.

The Bank of Japan's move mirrors a broader, renewed tightening cycle among major global economies. On Wednesday, the US Federal Reserve raised its benchmark interest rate for the first time in over three years, while the European Central Bank increased its borrowing costs earlier in September.