Bank of Japan Elevates Interest Rate to 1%, Highest Point Since 1995
The Bank of Japan (BOJ) announced on Tuesday an increase in its policy rate to 1%, a level not observed since 1995. This move by the central bank reflects an ongoing strategy to normalise monetary policy after an extended period of aggressive rate cuts in the 1990s and subsequent near-zero rates designed to counteract deflation and stagnant growth.
Economists, such as Jesper Koll, suggest that Japan is now navigating an inflationary upcycle, rendering previous "emergency/crisis management monetary policy" obsolete. The BOJ has been under considerable pressure to address inflation, which remained exceptionally low in the country until recently.
Higher energy prices, exacerbated by the US-Israel war with Iran, have been a primary driver of inflation, particularly impacting countries like Japan with a heavy reliance on Middle Eastern oil and gas imports. Wholesale prices in Japan climbed over 6% in May compared to the previous year, marking the fastest rise in three years. Despite this, the overall inflation rate in April stood at 1.4%, still below the BOJ's 2% target.
While acknowledging the risk of economic deterioration from the conflict, the BOJ stated that government measures to mitigate the impact of high fuel costs on households would likely lessen such a scenario. However, the bank also noted the risk of "underlying inflation deviating above our price target" due to continued increases in medium- and long-term inflation expectations.
The BOJ faces a delicate balancing act: raising interest rates could curb inflation, yet it simultaneously elevates borrowing costs for both the government and businesses. Governor Kazuo Ueda, a central figure in these decisions, was absent from this week's meeting due to hospitalisation for an infected liver cyst. Nevertheless, he and other policymakers have recently expressed an increasingly hawkish stance on rate increases.
Prime Minister Sanae Takaichi, who typically favours increased government spending, had previously dismissed the notion of hiking interest rates. However, she has refrained from publicly criticising the BOJ's shift towards higher rates since assuming office last year. This latest increase is the second since her tenure began, and it was largely anticipated following the BOJ's December adjustment of its policy rate to "around 0.75%."
The decision also serves to stabilise the yen, which has experienced depreciation against other major currencies, including the US dollar and the euro. Ulrike Schaede, a professor at the University of California San Diego, highlighted a prevailing sentiment that the yen is undervalued, and a rate hike would not be detrimental. Despite the increase, Japan's interest rate remains comparatively low when contrasted with major economies like the US and UK, which maintain rates above 3%.
