Bank of Japan lifts its policy rate to 1.25 percent, the highest since 1995

The Bank of Japan raised its uncollateralized overnight call rate by 0.25 percentage points to around 1.25 percent on 18 September, the highest setting since April 1995. The Policy Board voted 7-2 at the end of a two-day meeting. Toichiro Asada and Ayano Sato dissented. Asada wanted the rate left at about 1 percent. Sato said the moment was wrong for another increase.

The new target takes effect on Thursday next week. Monday through Wednesday are national holidays in Japan. Governor Kazuo Ueda spoke after the vote and described monetary policy as having entered a new phase, with upside risks to inflation now the board’s main concern.

This was the first hike since June and the shortest gap between increases under Ueda, who took office in 2023. An interval of about three months last appeared during the late-1980s bubble. Until this year the bank had talked about moving in roughly six-month steps.

Why the board moved now

Core consumer inflation in August stayed near the 2 percent target as firms kept passing higher food and grocery costs into shop prices. Energy costs linked to the Iran war and a weak yen have added to that pressure. Executive Director Koji Nakamura said earlier in the week that a shrinking labour pool is lifting wages in a way the bank cannot treat as a one-off.

The Federal Reserve raised rates on Wednesday. The European Central Bank took its key rate to 2.5 percent last week. A wider gap between Japanese and foreign rates has been one force behind the yen’s slide. Japanese authorities spent about $96 billion intervening in the currency market in July and August. U.S. Treasury Secretary Scott Bessent has publicly urged Tokyo to tighten faster.

The hike was widely expected. It still failed to lift the yen. The currency weakened after the announcement and traded through 157 per dollar. That reaction is the market saying a quarter-point move does not close the rate gap that has made the yen a cheap funding currency for decades.

What 1.25 percent actually changes

For households, mortgage and loan pricing will adjust only after the new target is in force next week. For banks, the overnight rate is now closer to what the BOJ itself has described as a neutral setting, the level that neither stimulates nor cools demand. For the rest of the world, the yen’s role in carry trades is the larger fact. Investors have borrowed in yen to buy higher-yielding assets elsewhere. Each BOJ increase raises the cost of that trade by a little. It has not yet reversed it.

Ueda’s “new phase” line matters more than the 25 basis points. It tells markets the board no longer sees itself as inching away from a zero-rate emergency. It sees inflation risks that can overshoot the 2 percent target and is willing to move on a quarterly clock. Two members of nine rejected that reading. The dissent is now part of the record and will be watched at the next meeting.

Energy is the open variable. If tanker traffic through the Strait of Hormuz stays thin and Japanese import prices stay high, the case for another hike in December or January will write itself. If the yen keeps falling after this move, the Ministry of Finance will face another intervention choice and the BOJ will face another rate choice on a shorter fuse than the old six-month script allowed.

The last time the policy rate sat at 1.25 percent, Japan was still living with the aftershock of the bubble. The country that has now returned to that number is older, more import-dependent for energy, and more exposed to a war that has already lifted fuel costs. The board voted as if those facts were no longer temporary.