TOKYO — The Bank of Japan has raised its benchmark interest rate to its highest level in 31 years, and Governor Kazuo Ueda is making it clear that the central bank is not ruling out further increases.
The BOJ lifted its policy rate by 25 basis points from around 1% to 1.25% on Friday, September 18, in a 7-2 vote. It was the first rate increase in three months and another major step away from the ultra-loose monetary policy that defined Japan’s economy for decades.
But the bigger story may be what comes next.
At a post-meeting press conference, Governor Kazuo Ueda said the BOJ has no predetermined timetable for future rate increases. Instead, policymakers will assess economic and price developments at every meeting, with the goal of keeping underlying inflation sustainably around the bank’s 2% target.
Ueda keeps bigger rate hikes on the table
Ueda said the BOJ would not rule out different possibilities, including larger or consecutive rate increases, if price conditions warranted such action.
However, he also stressed that the bank needs to examine incoming data carefully. The objective, he indicated, is to act early enough to prevent inflation from moving substantially above target rather than being forced into abrupt tightening later.
That leaves financial markets watching closely for the next signs of accelerating inflation.
The BOJ’s policy focus has also changed. Ueda said that while the bank previously concentrated on lifting underlying inflation toward 2%, underlying inflation is now approaching that level. The challenge is increasingly about stabilising inflation around 2% and preventing an excessive overshoot.
Why inflation is becoming a bigger concern
Japan’s inflation picture has become more complicated as higher energy costs, wage growth and changing inflation expectations feed through the economy.
Reuters reported that Japan’s core consumer inflation rose 1.7% year-on-year in August, while the BOJ’s preferred measure excluding fresh food and fuel increased 1.9%. The figures were close to the central bank’s 2% objective, although government energy subsidies have also affected the headline numbers.
Ueda pointed to stronger wage data and rising medium- and long-term inflation expectations as additional factors the BOJ is monitoring.
He also warned that a renewed increase in energy costs could put further pressure on wholesale prices and eventually consumer prices.
The yen delivered an unexpected reaction
Ordinarily, higher Japanese interest rates could provide support for the yen by narrowing the interest-rate gap between Japan and other major economies.
Yet the yen weakened after Friday’s BOJ decision.
Reuters reported that investors focused partly on the lack of a firm timetable for additional tightening and the two dissenting votes against the rate increase. The currency fell despite the BOJ’s move to its highest policy rate since 1995.
The division within the BOJ is significant because it illustrates the uncertainty surrounding the next stage of Japan’s monetary-policy normalisation.
Board members Toichiro Asada and Ayano Sato opposed the increase, producing the 7-2 vote.
BOJ faces a delicate balancing act
Ueda also acknowledged that financial conditions are becoming less accommodative as interest rates rise.
The governor said the BOJ needs to avoid tightening financial conditions too aggressively or triggering a large adjustment in asset prices. That means the central bank is balancing two competing risks: allowing inflation to overshoot its target versus raising borrowing costs so quickly that economic activity or financial markets are disrupted.
Another uncertainty is the so-called neutral interest rate — the level that neither significantly stimulates nor restrains economic activity.
Ueda said it is difficult to determine the neutral or eventual terminal rate in advance. Instead, the BOJ may gain a clearer picture as it adjusts policy and observes how the economy responds.
Global pressures are adding another layer of uncertainty
Japan is also dealing with forces beyond its borders.
Ueda cited developments involving other major central banks, currency movements, geopolitical tensions and strong demand linked to artificial intelligence as factors that could affect Japan’s economy and prices.
The BOJ’s latest increase also comes as other major central banks confront renewed inflation pressures, making Japan’s policy shift part of a broader global monetary-policy story.
Still, Japan’s policy rate remains below those of the US Federal Reserve and European Central Bank, highlighting the country’s continuing transition away from its exceptionally low-rate era.
What happens next?
For markets, the central question is no longer simply whether the BOJ can raise rates again.
It is how quickly and how far policymakers are prepared to go.
Ueda has deliberately left that question open.
The BOJ will assess inflation, wages, economic activity, financial conditions and external risks at each policy meeting rather than following a predetermined schedule. The central bank is also expected to provide a fuller assessment of the economic and inflationary impact of its policy changes in its next quarterly report.
For Japan, Friday’s move marks another historic step away from the country’s long era of ultra-low interest rates.
For investors, the more important signal may be that the BOJ’s policy phase has changed — but the destination is still uncertain.
And that uncertainty could keep the yen, Japanese bonds and Asian markets in focus well beyond Friday’s rate decision.
