BOJ lifts rate to 1%, a 31-year high, flags more hikes

The Bank of Japan raised its policy rate to 1% for the first time in 31 years and signaled further tightening, a landmark shift that will widen the gap between winners and losers across the economy.

The Bank of Japan raised its short-term policy rate to 1% from 0.75% on Tuesday, the highest level since 1995 and the first time borrowing costs have reached that threshold in three decades. The decision passed 7-1, with board member Toichiro Asada dissenting. Governor Kazuo Ueda missed the meeting and did not vote after being hospitalized for medical treatment, leaving Deputy Governor Shinichi Uchida to deliver the policy message.

"With underlying inflation approaching 2%, we need to be mindful of upward price risks. We will guide policy so that we won't fall behind the curve," Uchida told a news conference. The central bank said medium- and long-term inflation expectations have continued to increase, creating a risk that underlying inflation could deviate above its 2% target.

The BOJ also decided to pause its bond taper program from April 2027 and continue buying roughly 2 trillion yen ($12.5 billion) in Japanese government bonds per month. Japan's wholesale inflation rate hit 6.3% in May, a three-year high, as companies passed on higher energy costs linked to Middle East tensions. The yen remained largely flat at around 160 per dollar after the decision, while the Nikkei 225 rose to a record high as investors judged the BOJ in no rush to raise rates again soon.

The rate increase marks Japan's most aggressive step yet in exiting decades of ultra-loose monetary policy, but its effects will be unevenly distributed. About 90% of economists surveyed expect another hike by December, according to a Bloomberg poll, and Uchida's emphasis on upside inflation risks suggests the central bank is preparing markets for that outcome.

Depositors Gain, Borrowers Feel the Pinch

Mizuho Research & Technologies estimated that additional interest income on deposits could exceed the rise in household borrowing costs by about 1 trillion yen ($6.3 billion) annually, producing an average net gain of roughly 20,000 yen ($126) per household. MUFG Bank, Sumitomo Mitsui Banking Corp. and Mizuho Bank said Tuesday they would raise ordinary deposit rates from 0.3% to 0.4% beginning Aug. 3 — 400 times the 0.001% rate offered before the BOJ ended negative rates in March 2024.

The benefits, however, will concentrate among older households holding larger financial assets. Younger borrowers face higher costs, particularly the roughly 80% of Japanese mortgage holders who use variable-rate loans. Monthly payments on a 50 million yen ($314,000) variable-rate mortgage with a 35-year term would rise by 5,900 yen ($37) to 147,043 yen ($923) if the applicable rate increases to 1.25%, according to a Japanese mortgage comparison service.

Businesses are also exposed. Mizuho Research estimated that recurring profits across nonfinancial industries could decline by about 1%, or 1.1 trillion yen ($6.9 billion), with companies capitalized at less than 10 million yen ($63,000) facing a 6.6% profit hit.

Cross-Border Ripples

The rate hike narrows the interest rate gap between Japan and South Korea, where the Bank of Korea's policy rate stands at 2.5%. A stronger yen could improve import margins for Japanese subsidiaries of South Korean food and consumer goods companies while reducing the price advantage Japanese exporters have enjoyed from the weak yen. The gap could narrow further if the BOJ follows through on market expectations for another increase by year-end.

The divergent policy paths of the BOJ and the Bank of England — which voted 8-1 to hold its base rate at 3.75% on April 30 — have also put pressure on the GBP/JPY pair, with the yen strengthening after the BOJ's decision and threatening carry trade positioning in the currency pair.

The last time the BOJ raised rates to 1% was September 1995, when Japan was emerging from the asset price bubble's aftermath. This time, the context is reversed: the central bank is tightening to contain inflation, not to cool an overheated economy. If inflation overshoots around summer, the BOJ could hike again as soon as October, Nomura Securities strategist Mari Iwashita said. If not, a December move remains the base case.

This article is for informational purposes only and does not constitute investment advice.