The Bank of Japan raised its short-term policy rate by 0.25 percentage points to approximately 1% on Tuesday, bringing borrowing costs to their highest level since 1995. The move was widely expected and marks what analysts describe as a critical milestone in Japan’s effort to normalise monetary policy after decades of ultra-low interest rates and persistent deflation.
The last time Japan’s policy rate sat at 1% was during the early 1990s aftermath of its asset bubble collapse, when the central bank was in the process of cutting rates, not raising them. The direction of travel today is the opposite. Since exiting negative interest rates in 2024, the Bank of Japan has now raised rates three times, twice in 2025 and once on Tuesday, settling into a pattern of gradual tightening roughly every six months. An increasing number of economists expect at least one further increase before the end of 2026.
Tuesday’s decision was reached by eight members of the BoJ’s Monetary Policy Committee, following the hospitalisation last week of Governor Kazuo Ueda.
Why Japan Is Tightening Now
The driver is straightforward: Japan is finally experiencing the kind of sustained inflation that has eluded the country for most of the past three decades. For an economy that spent years battling deflation — falling prices that discourage spending and investment — the arrival of persistent inflation represents a fundamental shift in economic conditions, one that justifies moving interest rates back toward historically normal levels.
The broader global context matters here too. The Iran war has pushed energy prices sharply higher worldwide, and Japan, which imports virtually all of its energy, has felt that pressure acutely. Higher import costs have fed through into domestic inflation, reinforcing the BoJ’s case for continuing its tightening cycle even as other central banks weigh the growth consequences of elevated rates.
The Ripple Effects of a 1% Japanese Rate Are Larger Than They Appear
Japan’s interest rate decisions carry consequences well beyond its domestic economy, and that is the part of this story that markets need to watch carefully. For years, ultra-low Japanese rates fuelled what is known as the ‘yen carry trade’, investors borrowing cheaply in yen and deploying that capital into higher-yielding assets around the world, including US Treasuries, equities, and increasingly crypto. As Japanese rates rise and the yen strengthens, that trade becomes less attractive, and the unwinding of those positions exports volatility into global markets.
This dynamic played out sharply in August 2024 when a surprise BoJ rate move triggered a rapid yen appreciation and a sudden global risk-off selloff that briefly hit crypto markets hard. Tuesday’s move was well telegraphed and should be largely priced in. But with economists expecting further hikes, the cumulative pressure on carry trade positions will build gradually. For anyone holding risk assets, equities, bonds, or crypto, the Bank of Japan tightening toward levels not seen in a generation is not a local story. It is a slow-moving shift in global liquidity conditions that tends to matter most precisely when markets are already under stress from other directions.
