What's Happening?
The Bank of Japan (BOJ) has increased its benchmark interest rate by 25 basis points to 0.75%, marking the highest level since 1995. This decision aligns with the expectations of economists and is part
of Japan's ongoing policy normalization efforts. The move comes as inflation in Japan has remained above the BOJ's target for nearly four years, with consumer price growth recorded at 2.9% in November. The yen has weakened against the dollar, trading around 154-157, since Prime Minister Sanae Takaichi, who supports looser monetary policy, took office. The BOJ aims to create a 'virtuous cycle' of rising wages and prices, despite the challenges posed by Japan's high debt levels and a cost-of-living crisis.
Why It's Important?
The BOJ's decision to raise interest rates is significant as it reflects Japan's shift away from its previous negative interest rate policy, which had been in place since 2016. This move is intended to address persistent inflation and support economic stability. However, higher interest rates could exacerbate Japan's economic downturn, as the country's GDP contracted by 0.6% in the third quarter. The rate hike also raises the risk of increased borrowing costs, which could strain Japan's fiscal situation given its high debt-to-GDP ratio. The decision is crucial for Japan's economic stakeholders, including businesses and consumers, as it impacts borrowing costs, currency strength, and overall economic growth.
What's Next?
The BOJ projects that core inflation may decelerate below 2% from April to September 2026, influenced by government measures and a slower rise in food prices. Despite economic weaknesses, corporate profits are expected to remain high, and firms may continue to raise wages in 2026. The BOJ remains optimistic about maintaining a mechanism where both wages and prices rise moderately. The central bank's future actions will likely focus on balancing inflation control with economic growth, while monitoring the impact of higher interest rates on Japan's economy and fiscal health.
