By Leika Kihara and Makiko Yamazaki
TOKYO, Sept 18 (Reuters) - The Bank of Japan raised interest rates to a 31-year high on Friday and signalled its readiness to keep pushing up borrowing costs, joining other major central banks in fighting persistent inflation pressures driven by soaring oil costs.
The widely expected move, which was the first hike in three months, takes interest rates closer to levels the BOJ deems neutral to the economy, marking another step away from decades of ultra-low rates that
cemented the yen's status as a cheap global funding currency.
It follows rate hikes by its European and US peers, highlighting central banks' focus on global inflation risks caused by the Iran war-induced energy cost spike, expansionary fiscal policies and surging demand for AI investment.
At the two-day meeting ending on Friday, the BOJ raised its policy rate to 1.25% from 1% by a 7-2 vote. Dovish board members Toichiro Asada and Ayano Sato dissented to the decision.
"Wholesale inflation remains elevated and price pressures from business-to-business trading has started to spill over into consumer prices," the BOJ said in a statement announcing the decision.
"Underlying inflation has been approaching 2%" as companies continue to pass on the cost of higher wages and inflation expectations keep heightening, it said.
While economic and price developments are moving in line with the BOJ's baseline forecast, there was a risk of underlying inflation deviating from its 2% target, the statement said.
Markets are focusing on BOJ Governor Kazuo Ueda's news conference, scheduled at 3:30 p.m. (0630 GMT) for clues on the pace and timing of future rate hikes.
A hike to 1.25% brings the rate within the BOJ's estimated 1.1% to 2.5% range of Japan's nominal neutral rate, or the level that neither cools nor overheats growth, raising questions about how far it could eventually hike rates.
But the BOJ still lags global peers with its policy rate lower than that of the European Central Bank, which raised its key rate last week to 2.5%, and the Fed's 3.75%-4.00% range.
The still-wide rate divergence may keep the yen weak against other currencies, pushing up import costs and broader inflation.
The BOJ exited a decade-long stimulus in 2024 and has raised rates several times, including in June, at a pace of roughly twice a year on the view Japan was making progress in durably achieving its 2% inflation target.
Critics say the slow pace of BOJ hikes has been among factors keeping the yen weak, which, along with surging energy costs from the Iran war, have led to a spike in wholesale inflation that is seen spilling over to consumer prices.
AMBIGUITY MAY PREVAIL
Core consumer inflation held steady near the BOJ's 2% target in August, data showed on Friday, as companies continued to pass on rising costs for a wide range of food and grocery items.
Markets had nearly fully priced in September rate hike after a slew of hawkish BOJ signals, including its warning in July of the risk of an inflation overshoot from soaring fuel costs, rising import costs from a weak yen and strong AI demand.
US Treasury Secretary Scott Bessent also piled in, saying he voiced his strong support for "decisive" monetary steps to combat yen weakness in a meeting with Ueda this month, held on the sidelines of a G20 finance leaders' gathering.
In agreeing to join Japan's yen-buying intervention, Bessent also urged Prime Minister Sanae Takaichi's administration to avoid ramping up fiscal stimulus - a move running counter to the BOJ's efforts to rein in inflation, sources have told Reuters.
But many BOJ officials, including Ueda, have remained vague on the potential speed and degree of future rate hikes, arguing that much would depend on the inflation outlook and how the bank's past rate hikes could affect financial conditions.
Analysts polled by Reuters expect the BOJ to hike rates to 1.5% by end-March next year and then to 1.75% in the second quarter of 2027. Most saw the terminal rate as being at least 1.75%.
(Reporting by Leika Kihara and Makiko Yamazaki; Editing by Sam Holmes)
