Japan’s central bank raises interest rates to highest level since 1995

Japan’s central bank has raised interest rates to a three-decade high, citing price pressures stemming from the United States-Israel war on Iran.

The Bank of Japan (BOJ) on Tuesday voted 7-1 to hike its benchmark rate to 1 percent, a milestone in the country’s shift away from decades of rock-bottom borrowing costs.

The BOJ’s widely expected quarter-point hike lifted the key policy rate to its highest level since 1995, continuing its march away from an ultra-loose monetary policy aimed at reversing Japan’s economic stagnation.

In a statement, the BOJ said that while Japan’s rate of inflation has been on target, rising oil prices have filtered down to transactions among businesses, which could lead to higher prices “across a wide range of items”.

“Against this backdrop, taking into account that medium-to-long-term inflation expectations have also continued to rise, there is a risk of underlying CPI [consumer price index] inflation deviating upward to a level above the price stability target of 2 percent,” the central bank said.

Japan imported about 95 percent of its crude oil from the Middle East before the start of the war, leaving the world’s fourth-largest economy vulnerable to spikes in fuel prices.

Prime Minister Sanae Takaichi’s government has taken a series of measures to keep energy prices under control, including dipping into Japan’s strategic oil reserves and providing subsidies for households’ gas and electricity bills.

Japan’s core CPI, which does not include fresh food prices, rose just 1.4 percent in April year-on-year, which the BOJ credited to the government’s measures to “reduce the household burden of higher energy prices”.

Min Joo Kang, senior economist for South Korea and Japan at ING, said the rate hike signalled “a positive shift for Japan’s economy, suggesting progress toward sustained growth and price stability”.

“The BoJ now sees its sustainable inflation target of 2 percent as within reach, which supports its confidence in gradually normalising policy,” Kang told Al Jazeera.

The BOJ began moving away from decades of ultra-low and negative interest rates in 2024, scrapping its -0.1 percent rate with its first hike in 17 years in March of that year.

Japan was plunged into a prolonged period of anaemic growth and deflation, known as the “lost decades”, after the bursting of an asset bubble in the early 1990s.

Successive Japanese governments have had limited success reversing the decline although the economy has recently shown tentative signs of recovery.

Japan’s gross domestic product grew an annualised 2.1 percent in the first three months of this year, the fastest expansion in six quarters.