TOKYO - The Bank of Japan raised its policy interest rate from 1.0% to 1.25% on September 18, lifting borrowing costs to their highest level in 31 years as policymakers moved to contain growing inflation risks, but the yen weakened sharply after the decision as markets focused on two dissenting votes and uncertainty over the pace of further increases.
The 0.25-percentage-point increase followed the BOJ's previous rate hike in June, when the policy rate was raised to 1.0%, meaning the central bank has tightened policy twice within three months as it continues moving away from the ultra-low interest rates that characterized Japan's monetary policy for decades.
The yen fell immediately after the latest announcement, with selling accelerating rather than easing after the rate increase. The currency weakened into the 157-yen range against the dollar, its lowest level in about two weeks, prompting a strong reaction in foreign-exchange dealing rooms.
The rate increase itself had been widely expected, leaving investors more focused on the nine-member Policy Board's voting pattern and what it suggested about future monetary policy.
The decision passed by seven votes to two. Policy Board members Toichiro Asada and Ayano Sato opposed the increase, arguing that economic and price conditions were not necessarily strong enough to warrant another rise in borrowing costs.
The two were the first Policy Board members appointed under the administration of Prime Minister Sanae Takaichi, whose government has been viewed as cautious about rapid monetary tightening. Their dissent therefore raised questions in financial markets over whether political and economic concerns could limit the speed of future increases.
Behind the BOJ's decision is a growing concern that inflation, which for years was regarded as temporary and largely driven by imported costs, is becoming more firmly embedded in the Japanese economy.
One immediate concern is energy. Higher global oil prices have pushed up Japan's import bill, with the country heavily dependent on imported crude oil and other fuels. Those costs initially hit energy companies and manufacturers but can gradually spread through the economy as businesses pass higher transportation, materials and production expenses on to customers.
The weak yen adds to those pressures because imports priced in dollars become more expensive in yen terms. That means depreciation of the currency can raise the domestic cost not only of oil and gas but also food, raw materials, machinery components and a broad range of other imported goods.
The BOJ has also pointed to semiconductor prices and other internationally traded goods as potential sources of renewed inflation. While headline inflation has recently been relatively close to the central bank's 2% price stability target, policymakers are looking beyond current figures to the risk that higher costs will filter into consumer prices later in fiscal 2026.
Japan's changing wage environment is another major factor behind the tightening cycle. Persistent labor shortages caused partly by the country's shrinking working-age population have strengthened workers' bargaining position and encouraged companies to raise wages.
For the BOJ, sustained wage growth is important because it can transform inflation from a temporary increase caused by imported energy or raw materials into a broader cycle in which higher wages support consumer spending, companies raise prices to cover higher labor costs, and workers in turn seek further pay increases.
This process differs significantly from Japan's experience during decades of deflation and very low inflation, when companies were reluctant to raise prices and workers had limited ability to secure large pay increases.
Price-setting behavior among Japanese companies has also changed. After years in which businesses often absorbed increases in costs rather than risk losing customers by raising prices, repeated increases in food, energy, materials and labor costs have made price increases more common.
That shift matters to the BOJ because once households and businesses come to expect prices to rise regularly, inflation can become more persistent. Preventing expectations from moving significantly above the bank's 2% target is one reason policymakers are seeking to gradually raise interest rates before stronger inflation becomes entrenched.
The BOJ is therefore attempting to strike a balance. Raising rates too slowly could allow inflation and inflation expectations to accelerate, particularly if oil prices remain elevated or the yen weakens further. Raising them too rapidly, however, could hurt household spending, increase mortgage and corporate borrowing costs and weigh on an economy that still has areas of weakness.
Even at 1.25%, monetary conditions remain relatively loose by international standards, particularly when the policy rate is measured against inflation. The BOJ's approach has consequently been to normalize interest rates gradually rather than abruptly shift to tight monetary policy.
Higher rates can also support the yen by making yen-denominated assets more attractive relative to overseas investments. A stronger currency would in turn reduce the cost of imports and ease some inflationary pressure. The currency's fall after the September 18 decision, however, showed that markets are looking beyond the current rate and assessing how much further the BOJ is prepared to go.
The two dissenting votes reinforced expectations among some traders that future increases may proceed cautiously. The lack of an unexpectedly aggressive signal also encouraged yen selling after investors had already priced in the 0.25-point increase.
The result is an unusual situation in which the BOJ raised rates partly to contain inflationary pressures that have been intensified by a weak currency, only for the yen to weaken further immediately after the decision.
Governor Kazuo Ueda is scheduled to hold a news conference from 3:30 p.m. on September 18, with attention centered on whether he signals that further rate increases could come relatively quickly if inflation pressures persist.
His assessment of wages, oil prices, the yen and underlying inflation, as well as his comments on the significance of the two dissenting votes, will be closely watched for clues on how soon the BOJ may consider its next increase.
Source: TBS
