Bank of Japan raises rates to 31-year high

Japan’s central bank raised its benchmark interest rate to the highest level in 31 years on Friday, stepping further away from decades of ultra-low borrowing costs as rising prices, a weak yen and pressure from Washington sharpen the country’s economic challenges.

The Bank of Japan increased its main rate from 1% to 1.25%, a widely expected move that lifted borrowing costs to a level not seen since 1995. The quarter-point increase was the bank’s first rate hike since June and its sixth in the past two and a half years, following a long period in which the rate stood as low as minus 0.1% in 2024.

The move brings Japan closer to interest-rate levels the central bank considers neutral for the economy, while marking another step away from policies that helped make the yen a cheap global funding currency. The yen has been under pressure in recent months, and higher Japanese rates can support the currency by making it more attractive to traders.

Japan is facing a mix of rising prices, higher wages, a shrinking workforce and expensive energy imports. Official figures released before the Bank of Japan’s decision showed core inflation eased slightly to 1.7% in August from 1.8% the previous month, remaining near the bank’s 2% target. Al Jazeera reported that core consumer inflation held steady near target as companies continued passing on higher costs for a broad range of food and grocery items.

Inflation in Japan remains modest by many international comparisons, but rising prices are a relatively new pressure for an economy that experienced very low inflation or deflation for about three decades. The Bank of Japan has been raising rates since 2024 as it seeks to normalize policy after years of exceptionally cheap money.

Energy costs are adding to the strain. Global oil and gas prices have risen this year as the Iran war disrupted shipments through the Strait of Hormuz, a key shipping route. Japan is especially exposed to such supply interruptions because it relies heavily on energy from the Middle East.

The country also faces deeper structural pressures from demographics. Bank of Japan Executive Director Koji Nakamura said Monday that Japan is experiencing a “slow-moving demographic shock,” with a shrinking labor pool pushing up wages, a factor he said cannot be dismissed as temporary.

The rate increase comes as other major central banks are also tightening monetary policy. The U.S. Federal Reserve raised its benchmark interest rate on Wednesday for the first time in more than three years, while the European Central Bank increased borrowing costs earlier this month. Al Jazeera reported that the ECB’s key rate is now 2.5%.

The gap between U.S. and Japanese rates has drawn attention because further widening could weaken the yen and make imports more expensive, analysts told Reuters, according to Al Jazeera.

Washington has also pressed Japan to act. In August, Tokyo and Washington confirmed they had jointly intervened to stop the yen’s slide after it fell to a fresh 40-year low. The coordinated intervention was the first since 2011, when the two countries acted together to weaken the yen after the earthquake and tsunami that devastated eastern Japan.

Japan’s Ministry of Finance and U.S. Treasury Secretary Scott Bessent said at the time they would not hesitate to conduct more joint interventions. Bessent has also urged Bank of Japan Governor Kazuo Ueda to raise interest rates to support the yen, calling on him to “do the right thing.”

Markets are expected to watch Ueda’s post-meeting briefing closely for signals on the timing and pace of any further increases.