Bank of Japan Raises Key Policy Rate by 25 bps to 0.75%, Highest in 30 Years

On Friday, the Bank of Japan (BoJ) raised its key policy interest rate by 25 basis points to 0.75% which is the highest level since September 1995 and showing a clear resignation to turning the back on the years of ultra-loose monetary policy.

The decision made at the last policy meeting of the year by the central bank not only raised the benchmark rate from 0.5% to a 30-year high but also counted all votes for it. While widely anticipated by markets, the move has the potential to influence global currencies, bond markets and capital flows.

For years, Japan maintained near-zero or negative interest rates to combat deflation, even as other major central banks tightened policy aggressively after the pandemic. However, persistent inflationary pressures, rising wages and improving business sentiment have pushed the BoJ to continue its policy “normalisation,” despite the economy contracting at an annualised 2.3% pace in the previous quarter.

In its statement, the BoJ said that real interest rates would remain “significantly negative” even after the hike, and that accommodative financial conditions would continue to support economic activity. The central bank also noted that it expects the mechanism of moderate wage and price increases to remain intact.

The prolonged weakness of the yen is one of the main reasons for the rate hike. The Japanese currency has depreciated drastically against the US dollar and other major currencies, thus increasing the prices of imports like food, fuel, and other basic goods. It is expected that the higher interest rates will be a significant factor in stabilizing the yen since these rates will draw more international investors to Japanese assets.

Following the declaration, the yen saw a slight drop which indicates that the rise was more or less anticipated. The currency fell by over 0.3% to around 156 per dollar, whereas the euro and pound kept on rising against the yen.

This action is the fourth in a series of rate increases implemented by Governor Kazuo Ueda, who took over the helm in 2023 and gradually led the BoJ towards the normalization of policy. Markets are now eagerly looking forward to the central bank's guidance regarding the future, as more tightening in 2026 could considerably affect global markets, especially since Japan has historically been a provider of cheap capital.

According to analysts, the impact on emerging markets such as India will be determined mainly by the Bank of Japan's (BoJ) stance. A more hawkish scenario might lead to the faster liquidation of yen carry trades, thereby causing the outflow of foreign investors from stocks and other risky assets.

As Japan shifts to a different monetary policy, the global investors are trying to figure out how the continued rate increases and a stronger yen would impact the global financial conditions in the coming months.