Bank of Japan Hikes Interest Rates to Highest Level in 17 Years

resr 5paisa Research Team

Last Updated: 24th January 2025 - 12:10 pm

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The Bank of Japan (BOJ) increased interest rates on Friday to their highest level since the 2008 global financial crisis, signaling its confidence that rising wages will help sustain inflation around its 2% target.

This marks the BOJ’s first rate hike since July of the previous year and comes just days after the inauguration of U.S. President Donald Trump. His administration's stance on potential tariff hikes has kept global policymakers on high alert.

At the conclusion of its two-day meeting on Friday, the BOJ decided to raise its short-term policy rate from 0.25% to 0.5%—a level Japan has not seen in 17 years. The decision was passed with an 8-1 vote, with board member Toyoaki Nakamura dissenting.

The widely anticipated move highlights the central bank’s commitment to gradually increasing interest rates toward 1%, a level analysts consider neutral—neither stimulating nor cooling Japan’s economy.

"The likelihood of achieving the BOJ's outlook has been increasing," the central bank stated, citing firms that intend to continue raising wages in this year’s annual wage negotiations.

"Underlying inflation is rising toward the BOJ's 2% target," the statement added, noting that financial markets remain stable overall.

The BOJ maintained its forward guidance, affirming that future rate hikes would depend on its economic and price forecasts. However, it removed language emphasizing the need to carefully assess risks related to overseas economies and markets.

"Their reasoning remains unchanged. They are still far from neutral, so an adjustment is a logical step," said Naka Matsuzawa, chief macro strategist at Nomura Securities in Tokyo.

"Unless the BOJ either changes its rationale for rate hikes or revises the neutral rate—which they have been considering at around 1%—the market is unlikely to factor in many additional hikes moving forward."

Following the decision, the yen appreciated by about 0.5% to 155.32 per dollar, while the yield on two-year Japanese government bonds (JGBs) <JP2YTN=JBTC> climbed to 0.705%, its highest level since October 2008.

Attention now shifts to BOJ Governor Kazuo Ueda’s post-meeting briefing at 06:30 GMT, where analysts will look for clues on the pace and timing of further rate increases.

In its quarterly outlook report, the BOJ revised its inflation projections, now expecting core inflation to remain at or above 2% for three consecutive years.

The report also noted that inflation risks were tilted to the upside, citing worsening labor shortages, rising rice prices, and the impact of a weaker yen on import costs.

Regarding this year’s annual wage talks, "many firms have expressed intentions to continue raising wages steadily," the report stated.

The leader of Japan’s largest labor union federation told Reuters on Friday that wage increases must surpass last year’s 5.1% rise, as real wages continue to decline.

The BOJ now anticipates core consumer inflation to reach 2.4% in fiscal 2025 before easing to 2.0% in 2026. In its previous projection from October, it had forecast inflation at 1.9% for both years.

Meanwhile, its growth forecasts remain unchanged, with Japan’s economy expected to expand by 1.1% in fiscal 2025 and 1.0% in 2026.

Although the U.S. economy has remained strong and financial markets largely stable, the BOJ cautioned that uncertainties surrounding U.S. policy require close monitoring.

"The rate hike was anticipated, but for the first time in a long while, there were no significant downgrades to their economic outlook," said Matt Simpson, senior market analyst at City Index in Brisbane.

"This leaves room for another 25 basis point increase by year-end, bringing rates up to 0.75%."

Japan’s core consumer inflation accelerated to 3.0% in December, marking the fastest annual increase in 16 months, according to data released earlier on Friday. Rising fuel and food prices continue to drive up living costs for households.

Since taking office in April 2023, Governor Ueda has moved away from his predecessor’s ultra-loose monetary policy, dismantling the radical stimulus program in March of last year and increasing short-term interest rates to 0.25% in July.

BOJ officials have consistently stated that rate hikes will continue if Japan successfully establishes a cycle where rising inflation leads to higher wages and stronger consumer spending, enabling firms to pass on higher costs.

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