The Bank of Japan has increased its target short-term interest rate from 1% to 1.25%, marking the highest rate since 1995. This decision was supported by seven out of nine members of the central bank's board, according to a statement from the regulator.

The new rate will take effect on September 24, representing the first increase since June when the rate reached 1%.

Reasons Behind the Policy Tightening

The Bank of Japan cited rising price pressures as a key factor. Companies are increasingly passing on higher wages and production costs to consumers, leading to heightened inflation expectations.

Additional risks stem from soaring oil prices, a weakening yen, and global demand for AI-related equipment. This last factor has contributed to price increases in semiconductors and other tech goods.

According to the central bank, core inflation is approaching the target of 2% and is at risk of exceeding it. In the latter half of the fiscal year 2026, it may significantly surpass this target.

However, current official statistics present a more mixed picture. In August, consumer prices excluding fresh food rose by 1.7% year-on-year, down from 1.8% in July. The measure excluding food and energy increased by 1.9%.

Two board members of the Bank of Japan, Toichiro Asada and Ayano Sato, opposed the rate hike. Asada noted that inflation remains below 2% and the economy cannot be considered sufficiently robust. Sato did not observe a significant acceleration in economic activity or price growth that would justify the rate increase.

Despite these dissenting opinions, the central bank remains committed to further tightening its policy.

"The Bank will continue to raise the key interest rate and reduce the extent of monetary stimulus based on changes in economic activity, prices, and financial conditions," the statement said.

Analysts surveyed by Reuters anticipate the rate will rise to 1.5% by the end of March and reach 1.75% in the second quarter of 2027.

Market Reactions

The decision did not bolster the Japanese currency, as market participants had already factored in the increase. Following the announcement, the yen dropped by 0.8%, trading at 157.15 per dollar.

Investors were unsettled by the two dissenting votes and the lack of a more aggressive signal regarding the regulator's future actions. Ray Attrill, the chief currency strategist at National Australia Bank, remarked that the outcome was weaker than expected and indicated a lack of consensus within the board.

In contrast, the Japanese Nikkei 225 index gained approximately 0.8% in response.

The price of Bitcoin rose by 1.4%, reaching around $77,600. Ethereum saw a 1.8% increase, trading around $2,500 at the time of writing.

Hourly chart of BTC/USDT on Binance. Source: TradingView. Hourly chart of ETH/USDT on Binance. Source: TradingView.

The interest rate hike in Japan is significant for cryptocurrencies due to carry trade dynamics, where investors borrow relatively cheap yen to invest in higher-yielding assets.

An increase in the cost of such loans could lead to position closures and sell-offs. However, this time the markets had already anticipated the rise, which softened the overall reaction.

It is worth noting that in July, the United States and Japan conducted a joint currency intervention after the yen fell nearly to 164 per dollar. For further insights into why the Japanese currency remains a risk factor for global liquidity, U.S. debt, and Bitcoin, check out our long-read article.