The Bank of Japan (BoJ) has raised interest rates by 0.25 to 1.25 percent, pushing borrowing costs to their highest level in 31 years, amid rising inflation and wages, and pressure from Washington.

Historic Move Closes in on Neutral Rates

The move on Friday marked the first hike since June, and takes interest rates closer to levels the BoJ deems neutral to the economy, marking another step away from decades of ultra-low rates that cemented the yen’s status as a cheap global funding currency.

Inflation Challenges and Rising Costs

Japan is grappling to contain inflation, which is being driven by factors including rising energy prices, global supply pressures and domestic inflation exceeding the 2 percent target.

Core consumer inflation held steady near the target in August, data showed on Friday, as companies continued to pass on rising costs for a wide range of food and grocery items.

The country also faced a “slow-moving demographic shock” with a shrinking labour pool lifting wages, a structural factor that cannot be dismissed as temporary, BoJ Executive Director Koji Nakamura said on Monday.

Global Rate Hikes Influence Domestic Policy

The Federal Reserve’s rate hike on Wednesday, and the prospect of another one later this year, have added pressure on the BoJ to keep pace.

Further widening of the United States-Japan rate gap risks weakening the yen and lifting inflation through higher import costs, analysts told the Reuters news agency.

Its policy rate also remains lower than the European Central Bank, which raised its key rate to 2.5 percent last week.

Such pressure could affect the tone of BoJ Governor Kazuo Ueda’s post-meeting briefing, which will be closely watched by markets for clues on the timing and pace of further increases.

Japan’s central bank has raised its main interest rate to a fresh 31-year high as it continues to move away from decades of ultra-low borrowing costs and as the country faces increasing economic pressures.

In a widely expected move on Friday, the Bank of Japan (BOJ) increased the rate from 1% to 1.25% – a level not seen since 1995.

It comes as major central banks around the world are hiking rates as higher energy prices caused by the Iran war are helping to push up inflation.

On Wednesday, the US Federal Reserve raised its benchmark interest rate for the first time in over three years, while the European Central Bank also increased its borrowing costs earlier this month.

The BOJ has been raising the rate since 2024, when it stood at minus 0.1% — it has now hiked rates six times in the last two and a half years.

Since then the bank has been steadily putting up the rate as it tries to reach a level similar to other major economies.

When a central bank raises rates, the country’s currency usually becomes stronger as it makes it more attractive to traders.

Japan is facing several economic challenges including a persistently weak yen, rising prices and a shrinking workforce.

Official figures published on Friday ahead of the BOJ announcement showed that inflation eased slightly last month.

Core inflation fell to 1.7% in August from 1.8% the previous month but remains close to the bank’s 2% target level.

While Japan’s inflation rate is not high by international standards, rising prices are a relatively new development in the economy.

Until recently the country had experienced very low inflation or deflation – falling prices – for around three decades.

Global oil and gas prices have risen this year as the Iran war caused major disruptions to shipments through the key Strait of Hormuz shipping route.

Japan is particularly vulnerable to those supply interruptions as it is heavily reliant on energy from the Middle East.

The country’s currency has also been under pressure in recent months.

In August, Tokyo and Washington confirmed that they had jointly intervened to halt a slide in the yen after it fell to a fresh 40-year low.

The coordinated intervention was the first since 2011, when both countries took action together to weaken the yen after the devastating earthquake and tsunami that hit eastern Japan.

Both Japan’s Ministry of Finance and US Treasury Secretary Scott Bessent said at the time that they would not hesitate to conduct more joint interventions in the future.

Bessent has also been ramping up pressure on the BOJ to raise interest rates to help support the yen, calling on its Governor Kazuo Ueda to “do the right thing”.