Japan Raises Rates: A First Step Towards Breaking the Deadlock?

Inflation Falls, Yet Rates Rise

On September 18, the Bank of Japan raised its policy rate by 25 basis points to 1.25%, its highest level since 1995. Data released the same day showed annual core CPI inflation of 1.7% in August, down from 1.8% in July—the first decline in four months.

Policy Enters a New Phase

At his regular press conference on September 18, Bank of Japan Governor Kazuo Ueda said monetary policy had entered a new phase. Further rate increases would depend on economic and inflation data, with no predetermined timetable or fixed pace.

Since ending negative interest rates in March 2024, Japan had raised rates roughly once every six months. This increase came just three months after the previous one, the shortest interval since 1990.

Government Subsidies Explain the Small CPI Decline

The 0.1-percentage-point decline in August core CPI inflation was largely driven by energy. Annual energy-price growth fell from 0.6% in July to −0.7% in August, with petrol and electricity prices down 2.6% and 2.4%, respectively. Excluding fresh food and energy, core CPI inflation remained at 1.9%, unchanged from July.

The Bank of Japan also noted the effect of government measures to reduce energy costs. The small decline in CPI was therefore mainly subsidy-driven; underlying inflation had not really cooled.

The Bank Is Watching for Upstream Inflation to Spread

The corporate goods price index rose 7.6% year on year in August, its third consecutive month above 7%. Import prices measured in yen rose 24.8%. The central bank attributed elevated wholesale prices to expanding AI demand, higher oil prices and a weaker yen, and judged that price pressures on businesses had begun to spill over into consumer prices.

The bank expected CPI inflation to rise clearly above 2% in the second half of fiscal 2026. Policy was responding not to the current 1.7% inflation rate, but to the risk of future increases. That was one reason for the rate hike.

Why Didn’t the Yen Strengthen?

A rate increase should have supported the yen, but that did not materialise this time. Following the decision, the dollar rose against the yen in short-term trading, reaching 156.74 yen at 11:05 a.m. Beijing time. For comparison, policy rates in the major economies stood at 3.75%–4.00% in the US, 1.25% in Japan and 2.50% in the euro area.

Even after the increase, the US–Japan interest-rate gap remained wide. A weak yen raises import costs and domestic prices—an argument in itself for further rate increases.

What to Watch Next

Although Japan’s policy rate had reached its highest level since 1995, it remained low compared with those of other major economies. The next monetary policy meeting was scheduled for October 29–30. For markets, the supply of inexpensive yen funding was still undergoing a continuing tightening process.