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 after a two-day meeting. The new target takes effect on Thursday, 24 September. Monday through Wednesday are national holidays in Japan.

Board members Toichiro Asada and Ayano Sato dissented. Asada wanted the rate left at around 1 percent. Sato said the timing was wrong. The 7-2 split was the first hike in three months, the shortest interval under Governor Kazuo Ueda, who took office in 2023. An interval that short last appeared during the late-1980s bubble.

Why the board moved

The bank has been stepping away from a decade of near-zero rates since it exited large-scale stimulus in 2024. It held at 0.75 percent through the spring, raised to 1 percent in June, held again in July, and has now gone to 1.25 percent. The staff case is that underlying inflation is close enough to the 2 percent target that the risk has flipped. Too little tightening could let energy costs and a weak yen push prices through the target. Too much tightening could stall wages and consumption.

Ueda told his news conference that the policy focus has shifted. “If risks of underlying inflation overshooting 2 percent materialise, that could have a negative impact on Japan’s economy,” he said. Oil prices have been volatile through the Iran war and the squeeze on the Strait of Hormuz. The yen has been a cheap funding currency for years. A higher Japanese rate chips at that carry trade, at least in theory.

The theory did not show up in the first tick. The yen sank to about 156.91 per dollar after the announcement. Traders treated the 25-basis-point step as the base case and read the two dissents as a sign that the next hike is not locked in. The bank’s own estimate of Japan’s nominal neutral rate sits in a band from about 1.1 percent to 2.5 percent. At 1.25 percent the policy rate has entered that band. How far the board is willing to travel inside it is the open question for the 29-30 October meeting.

What the vote tells you about the next step

Ueda has preferred a pace of roughly two hikes a year. Friday’s decision broke that rhythm. Energy inflation and a soft currency gave the hawks their case. The two dissenters gave the doves a marker they can point to if growth slows or if oil comes off. Markets will now parse every line of the October outlook for a signal that 1.50 percent is in play before year-end.

For households, the overnight rate is still low by American or European standards. For banks, insurers and the Ministry of Finance, it is a different arithmetic. Coupon costs on new government debt rise. Variable mortgage rates follow with a lag. Exporters who liked a cheap yen lose a little of that cushion. Importers of crude, who have been paying war-risk premia since February, get no relief from a 25-basis-point move.

The practical detail that will show up first is the calendar. Because the new target waits until 24 September, money markets have a holiday week to reposition. The next scheduled meeting is 29-30 October. December 17-18 is the last sitting of the year. If Ueda means what he said about a shift in focus, those two dates are where the board either confirms the new phase or shows that 1.25 percent was a one-step answer to an oil spike.