The Bank of Japan raised its benchmark interest rate to 0.5% on Friday, marking its highest level since 2008, as the central bank moves to address persistent inflation and rising wages. The decision underscores a shift in monetary policy for a nation that has long struggled with stagnant price growth and economic stagnation.
The decision to raise rates by 25 basis points was supported by a majority of the BOJ's policy board, with an 8-1 vote in favor. Toyoaki Nakamura, the lone dissenting voice, argued that the central bank should wait for further evidence of improved corporate earnings before taking action. The policy change comes as Japan grapples with a combination of accelerating consumer price increases and rising wages, signaling the start of what Governor Kazuo Ueda calls a "virtuous cycle" of economic growth.
The move followed the release of fresh economic data showing core consumer prices rose 3% in December from a year earlier, the fastest pace in 16 months. Headline inflation reached 3.6%, the highest since January 2023. These figures indicate that inflation has firmly taken hold, driven by higher import prices and a depreciating yen.
The yen strengthened modestly, rising 0.6% to 155.12 against the dollar following the announcement, while Japan's Nikkei 225 stock index recorded slight gains. Meanwhile, yields on 10-year Japanese government bonds climbed to 1.23%, reflecting investor expectations of further rate increases.
The BOJ's shift is part of a broader strategy to normalize monetary policy after years of ultra-low interest rates. Officials are closely monitoring wage growth, with the spring "shunto" labor negotiations expected to bring another round of significant pay hikes. Deputy Governor Ryozo Himino emphasized the importance of continued wage growth in a recent address to business leaders, stating that strong wage hikes are critical to sustaining the current economic momentum.
Tomoko Yoshino, president of the Japanese Trade Union Confederation (Rengo), has called for annual wage increases of at least 5% in the upcoming negotiations. Yoshino argued that higher pay is necessary to offset the impact of inflation on workers' purchasing power and to narrow income disparities between employees at smaller and larger firms.
Economists expect the BOJ to continue raising rates gradually. Vincent Chung, co-portfolio manager at T. Rowe Price, projected that the policy rate could reach 1% by the end of the year, aligning with the lower end of the central bank's neutral rate range.
The rate hike comes just months after Japan intervened in foreign exchange markets to stabilize the yen, which hit a 36-year low against the dollar last July. The government spent approximately 15.32 trillion yen ($97 billion) throughout 2024 to shore up the currency. While officials have expressed concern about yen volatility, substantial interventions are considered unlikely this year.
The BOJ's decision is not without risks. Higher interest rates could weigh on borrowing costs for businesses and households, potentially slowing economic growth. However, by raising rates now, the central bank gains flexibility to lower them in the future should economic conditions warrant.
The timing of the move also coincides with external pressures, including potential policy shifts by the U.S. Federal Reserve and trade uncertainties. President Donald Trump, who recently returned to the White House, has threatened to impose tariffs on imports, which could have implications for export-driven economies like Japan.
Economists such as Stefan Angrick of Moody's Analytics anticipate another 25-basis-point hike within six months, contingent on continued economic growth and inflation remaining above the BOJ's 2% target.