The Bank of Japan (BOJ) raised interest rates to their highest level in 31 years on Tuesday, taking another major step away from its long era of ultra-loose monetary policy as rising energy costs from the Iran conflict added fresh inflationary pressure.
In a widely expected move, the Japanese central bank increased its short-term policy rate to 1% from 0.75%, pushing borrowing costs to their highest level since 1995.
The decision was approved by a 7-1 vote. BOJ Governor Kazuo Ueda did not participate in the meeting as he is undergoing treatment in hospital for an infected liver cyst.
The central bank said the increase in crude oil prices had begun to flow through the economy and could lead to broader price increases.
“The price pass-through stemming from rising crude oil prices has been progressing at a relatively fast pace in business-to-business transactions, which could spread to an increase in consumer prices across a wide range of items,” the BOJ said in a statement quoted by Reuters.
“Taking into account that medium- and long-term inflation expectations have also continued to increase, there is a risk of underlying inflation deviating above our price target,” it added.
Japan’s monetary policy path has become more complicated due to the impact of the conflict in West Asia, which has pushed up energy prices and increased costs for countries dependent on imported fuel.
Although the peace agreement between the United States and Iran eased immediate concerns over a prolonged oil supply disruption, Japanese companies had already started passing higher energy costs to consumers.
Reuters reported that Japan’s wholesale inflation rose to a three-year high of 6.3% in May, indicating that companies were transferring the burden of higher input costs to customers.
Analysts expect Japan’s core consumer inflation to move above the BOJ’s 2% target again later this year after temporarily falling due to government subsidies on utility bills.
The BOJ had kept interest rates unchanged in its April meeting but increased its inflation forecasts and warned of the possibility that prices could rise faster than expected.
Since then, markets had increasingly priced in a rate increase in June. A Reuters poll showed economists expect the BOJ to raise rates further to 1.25% in the fourth quarter of this year.
However, the central bank appears likely to move gradually.
“If anything, the focus had been on whether a 50-basis-point rate hike would be proposed, but no such proposal was made. In terms of the future rate-hike path, this is positive for risk asset prices, as it suggests that a sharp rate hike is likely to be avoided,” Hirofumi Suzuki, chief FX strategist at SMBC, told Reuters.
Suzuki added that the BOJ was likely to continue raising rates gradually at a pace of roughly once every six months to one year.
Japanese markets reacted positively to the announcement. The Nikkei 225 index rose as much as 1% to hit a record high above 70,000.
The Japanese yen also strengthened slightly, rising 0.1% against the US dollar, while the yield on the benchmark 10-year Japanese government bond climbed 3.5 basis points to 2.61%.
The BOJ also announced that it would pause its bond tapering programme from April next year and continue purchasing around 2 trillion yen (around $12.5 billion) worth of Japanese government bonds every month.
Attention will now shift to Deputy Governor Shinichi Uchida, who is scheduled to address the media in place of Ueda.
According to Reuters, analysts expect Uchida to maintain a cautious but hawkish tone while avoiding clear signals on the timing of the next interest rate increase.
The BOJ’s decision comes during a crucial week for global central banks. The US Federal Reserve is widely expected to keep rates unchanged, although investors are closely watching whether persistent inflation concerns could delay future rate cuts.