TOKYO - The Bank of Japan lifted its key policy rate to a 31-year high of 1.0 percent on Tuesday following a two-day policy meeting, as it tackles rising inflation risks stemming from elevated crude oil prices due to the Middle East conflict and the weak yen.
The central bank, in the absence of Governor Kazuo Ueda who has been hospitalized for treatment of a hepatic cyst infection, raised the short-term interest rate from 0.75 percent in its first hike since December. The recent U.S.-Iran agreement to end the war may have also affected the decision.
The BOJ said in its statement that there is a risk of underlying inflation rising above its target of 2 percent as rises in crude oil prices lead companies to hike prices in business-to-business transactions "at a relatively fast pace," which could "spread to an increase in consumer prices across a wide range of items."
The bank will continue to raise the policy rate in response to developments in economic activity and prices as well as financial conditions, the statement said.
The bank also noted that the risk of a significant slowdown in the economy appears to have decreased, due partly to the government's efforts to secure alternative sources of supply of raw materials for which Japan has been highly dependent on the Middle East.
Among the remaining eight policymakers excluding Ueda who discussed the policy change, the rate hike decision was opposed by Toichiro Asada, viewed by the market as a proponent of reflationary policies in favor of aggressive monetary easing, who joined the Policy Board in April.
The bank also said it will slow the pace of reductions in Japanese government bond purchases from April 2027, while maintaining the current pace of reducing them by about 200 billion yen every quarter through March 2027, a decision coming at a time when yields on long-term interest rates have been rising rapidly.
The monthly amount of bonds purchased will be cut to around 2.1 trillion yen in the January-March period and to about 2 trillion yen from April 2027, according to the plan.
The BOJ decided in July 2024 to cut back its monthly government bond purchases as part of its efforts to normalize monetary policy after a decade of unorthodox easing. But it has said that in the event of a rapid rise in long-term bond yields, it could increase bond buying.
While raising the key policy rate could cool the economy by increasing borrowing costs for companies, restraining investment and dampening private spending, the central bank saw the need to respond to inflation risks following the U.S.-Israeli attacks on Iran in late February and subsequent surges in crude oil prices.
The yen repeatedly falling to the 160 zone against the U.S. dollar, despite the Japanese authorities intervening in the currency market from late April to early May to curb the unit's fall, has also stoked concerns about rising import costs for resource-poor Japan.
Even if the U.S.-Iran conflict ends following the two countries' agreement to end the monthslong war, shipping through the Strait of Hormuz may not immediately stabilize, keeping transport, raw material and other costs elevated, analysts said.
But the agreement will relieve fears of disruptions in Japan's supply chains, serving to reinforce the view that the economy is resilient enough to withstand further rate hikes, they said.
The decision to raise the rate puts the BOJ in line with other central banks shifting towards tightening of monetary policy amid inflationary pressures, such as the European Central Bank, which hiked its rate last week.
In a speech earlier this month, Ueda cautioned against secondary spillover effects of inflation stemming from higher crude oil prices, which initially affect plastic products, electricity charges, and distribution costs but extend to final goods and services, including automobiles, construction, accommodation and eating and drinking services.
Inflation risks have been flagged after Japan's wholesale prices rose 6.3 percent in May compared to a year earlier -- the biggest increase in over three years. Firms are increasingly passing on rising costs from the war in Iran to the prices of their goods and services.
The data suggested that core consumer inflation may also accelerate, although it has been kept below the bank's 2 percent target because of government subsidies for electricity, gas and gasoline, the analysts said.
