TOKYO - The Bank of Japan raised its policy rate from 1.0% to 1.25% on September 18, taking borrowing costs to their highest level in 31 years and accelerating the pace of monetary tightening as persistent inflation and concerns over fiscal expansion put upward pressure on interest rates.
The decision marked another step away from the ultra-low-rate policies that dominated Japan for decades. After ending its negative interest rate policy in 2024, the BOJ had generally raised rates at intervals of around six months, but the latest increase came only three months after the previous move.
The decision was not unanimous. Two members of the BOJ Policy Board opposed the increase, both of whom were appointed under the administration of Prime Minister Sanae Takaichi. Their dissent prompted speculation in financial markets that further rate increases could face greater resistance.
The yen weakened after the decision, briefly falling into the 157-yen range against the dollar, its lowest level in about two weeks.
Attention then shifted to comments from BOJ Governor Kazuo Ueda, who said underlying inflation was approaching 2% and stressed the importance of stabilizing it around that level.
Ueda said the "phase of policy has changed," language that was not included in the BOJ's official statement and was interpreted by some market participants as a signal that the central bank was preparing for further tightening.
One market strategist said another increase could come by December and that the policy rate could potentially reach 2% by around the summer of next year.
For households, one of the most immediate effects will be higher variable mortgage rates, which move in response to changes in short-term interest rates. Rising rates could push up monthly repayments and place additional pressure on household finances.
One couple who chose a variable-rate mortgage said they had borrowed about 60 million yen over 40 years. They said housing costs had become noticeably higher compared with when they first entered the workforce about a decade earlier.
Inflation has been the main reason for the BOJ's shift toward higher rates. Consumer prices fell year on year during parts of the COVID-19 pandemic but later climbed sharply following Russia's invasion of Ukraine and other increases in global costs.
The return of higher interest rates is also being felt in agriculture, where expansion and modernization often require large amounts of borrowed capital.
Takahiro Yamaguchi, a ninth-generation rice farmer in Inashiki, Ibaraki Prefecture, has expanded his cultivated area from about 12 hectares during his father's generation to 127 hectares, supported in part by a prefectural program encouraging the development of large-scale rice farms.
Yamaguchi is aiming eventually to cultivate 200 hectares, but the expansion has required substantial investment in machinery and technology.
A rice-drying machine costs about 3 million yen, while equipment purchased for automated and unmanned agricultural work has included two self-driving machines and two robotic tractors. One robotic tractor equipped with attachments cost around 13 million to 15 million yen.
Yamaguchi said he has borrowed more than 100 million yen as his operation expanded. Some of his loans from a regional bank carry variable interest rates, meaning rising rates could affect the pace and scale of his future investment plans.
"Costs are increasing, including interest rates, so that could change how we proceed and how quickly we expand," he said.
Farmers are also contending with sharp increases in pesticides, fertilizer and other agricultural materials. Yamaguchi said some input costs have risen by about 50% over the past five to 10 years, while others have roughly doubled.
Rice prices have also fluctuated sharply, making investment decisions more difficult. Yamaguchi said that if rice prices remain high, increased costs can be absorbed more easily, but falling prices would make conditions considerably harder.
Higher interest rates have brought benefits for savers, however, and banks have stepped up competition to attract deposits.
Following the BOJ's latest increase, Japan's three megabanks announced that they would raise ordinary deposit rates from 0.4% to 0.5%.
Another bank recently revamped its savings deposit product for the first time in 17 years, offering progressively higher rates depending on the size of deposits and paying interest monthly rather than every six months. Applications to open accounts were reportedly about eight times the normal level within roughly a week of the announcement.
Deposits, once regarded as a burden on bank earnings during the negative-rate era, have become more valuable as financial institutions can use them to support profitable lending.
For borrowers, the change has been far more painful.
The president of a restaurant company operating three locations in Tokyo showed loan records indicating that the interest rate on borrowing from another financial institution had risen from 0.19% three years earlier to 3.2%, an increase of nearly 17 times.
He said the difference may appear small when expressed simply as a change of one or two percentage points, but the increase becomes much more significant when translated into actual interest payments over five or 10 years.
The company is also dealing with rising food and wine costs and higher rents while struggling to pass all of those increases on to customers.
A credit union supporting small and midsize businesses said similar concerns were spreading among its clients.
One transportation company, already dealing with higher fuel and wage costs, said small businesses would have difficulty keeping pace if interest rates continued rising quickly.
An employee responsible for around 50 corporate clients said an increasing number of companies were questioning whether they should borrow at all as financing costs climbed.
Small and midsize businesses account for about 99% of Japanese companies and are particularly exposed to changes in borrowing costs. Tokyo Shoko Research estimates that if interest rates were to rise by another one percentage point, the proportion of companies operating at a loss could increase from the current 27.7% to around 31%.
Credit unions are responding by holding seminars and providing additional financial advice to businesses facing the combined pressures of labor shortages, inflation, higher material costs and rising interest rates.
Ueda indicated after the September 18 meeting that the BOJ intends to continue increasing its policy rate and reducing the degree of monetary accommodation if economic, price and financial conditions develop in line with its outlook.
Fiscal policy has become another important factor in the debate over future interest rates.
The Takaichi administration has emphasized what it calls "responsible proactive fiscal policy," arguing that economic growth is necessary to maintain the sustainability of government finances and provide funding for social security.
A recent Cabinet reshuffle retained Finance Minister Katayama and other ministers responsible for economic policy, signaling that the government intends to continue its expansionary fiscal stance.
Budget requests for fiscal 2027 have exceeded 143 trillion yen, the highest level on record, while the government this week approved tax reform measures including a one-percentage-point reduction in the consumption tax on food.
The government has said details of how the measures will be financed will be presented during the budget compilation process, but criticism has emerged over approving spending and tax cuts before clearly identifying funding sources.
Concerns are growing that additional fiscal expansion could worsen Japan's public finances, push long-term interest rates higher and add to inflationary pressure, potentially forcing the BOJ to tighten monetary policy more rapidly.
A former BOJ Policy Board member said the circumstances differ substantially from those that prevailed when Abenomics was introduced. At that time, Japan was struggling with deflation and extremely weak inflation, while the current environment is characterized by rising prices.
He argued that aggressive fiscal policy can itself accelerate inflation when implemented in an already inflationary environment, increasing the risk that financial markets will demand higher yields on government debt.
Bond markets can also impose limits on fiscal policy by pushing borrowing costs higher when investors lose confidence in a government's finances. The experience of Britain's short-lived Truss government, whose unfunded tax-cutting plans triggered a sharp selloff in government bonds and soaring yields, has been cited as an example of the pressure financial markets can exert on policymakers.
Japan is therefore entering a markedly different financial environment after decades in which borrowing costs were close to zero. Higher deposit rates are improving returns for savers and bank profitability, but households with mortgages, farmers making large capital investments and small businesses dependent on bank loans are facing rising financing costs at the same time as they contend with inflation, labor shortages and higher operating expenses.
For companies that have become accustomed to exceptionally cheap financing, the shift could force fundamental changes in borrowing, investment and expansion plans as the BOJ moves further into what has become a renewed "world with interest rates."
Source: TBS
