The Bank of Japan is one of the few major central banks in the world that is going against the trends set by the Fed.
The Bank of Japan (BoJ) has raised its benchmark interest rate to 0.75 percent, the highest level in about 30 years, marking a significant departure from decades of ultra-loose monetary policy that have defined Japan’s post-economic-stagnation era and a turning point for the global financial landscape.
Following years of historically low and occasionally negative interest rates, Governor Kazuo Ueda’s ongoing efforts to normalize monetary settings have culminated in this unanimous decision by the BoJ’s policy board. It reflects the central bank’s growing confidence that inflationary pressures have gained enough traction to warrant tighter monetary conditions rather than being a transient phenomenon.
Japan’s monetary policy has been characterized for the majority of the last thirty years by efforts to combat persistent deflation and stagnant growth. In an effort to boost borrowing, investment, and consumer spending following the burst of the asset price bubble, the BoJ began implementing zero-interest-rate and later negative-interest-rate policies in the mid-1990s.
Raising rates to 0.75 percent is a significant change from that period. The increase is noteworthy for Japan even though it is small by global standards. The BoJ has been cautious, moving only slowly in the direction of higher borrowing costs, in contrast to central banks in the US and Europe, which have spent recent years aggressively tightening before modestly pivoting.
The BoJ’s belief that inflation is becoming entrenched is the driving force behind this change in policy. For more than three years, Japan’s core consumer price index (CPI) has been higher than the bank’s 2% target. This period of persistent inflation has been mostly caused by higher import costs brought on by a weak yen and ongoing supply pressures from around the world.
Japan‘s overall economy, however, paints a complex picture. Even as price pressures continue, recent data indicate a slight economic contraction, highlighting the vulnerability of domestic growth. Therefore, the leadership of the BoJ must weigh the risk of overtightening against the peril of allowing inflation expectations to become unanchored.
Global financial markets responded quickly to this announcement. As expected, the value of the yen depreciated against key currencies, though the expectation was that a tight monetary policy would strengthen it. In contrast, yields of Japan’s 10-year government bonds rose to their highest level in several years.
In equity markets, relatively greater resilience was shown, with the Nikkei 225 index rising modestly in the wake of the announcement–perhaps in recognition that the increase had been factored into prices.
What the Japanese economy’s move means is not limited to the global markets. The BoJ is one of the few major central banks in the world that is going against the trends set by the Fed, among others, which has recently shown signs of reducing interest rates.
Such higher interest rates could make less attractive so-called “carry trades,” in which investors borrow funds in low-yield currencies, such as the yen, to invest in other higher-yielding currencies, a phenomenon that has occurred for years. Higher interest rates could also lead Japanese investors to bring their money back home, potentially impacting international asset prices.
Looking ahead, the BoJ has made clear it remains prepared to adjust policy further if economic conditions evolve in line with forecasts. Analysts suggest that future rate rises may be measured-perhaps incremental increases over the coming year-rather than dramatic hikes.
Market attention is focused on the upcoming press conference by Governor Ueda as the market awaits any information on the BoJ’s view on the concept of “neutral rate,” which is defined as a point where money policy is neither expansionary nor contractionary. Another important point that investors would be eager to hear is expectations regarding wage growth challenges.
