Kazuo Ueda, governor of the Bank of Japan (BOJ), during a committee on financial affairs meeting at the lower house of parliament in Tokyo, Japan, on Friday, Nov. 21, 2025.Getty Images
Japan’s central bank has taken another decisive step away from ultra-loose monetary policy. On Friday, the Bank of Japan (BOJ) raised interest rates to their highest level in three decades, pressing ahead with normalization as inflation remains stubbornly above target.
The BOJ lifted its benchmark policy rate by 25 basis points to 0.75 per cent. The move matched expectations from economists surveyed by Reuters and marks the highest level since 1995.
Policy Shift Continues Despite Risks
Despite the rate increase, the central bank stressed that financial conditions will remain accommodative. It said real interest rates are still expected to stay “significantly negative,” ensuring continued support for economic activity.
Japan began dismantling its long-running stimulus framework last year. The BOJ ended the world’s only negative interest rate regime, which had been in place since 2016.
Since then, policymakers have consistently signalled a gradual path toward higher rates. Their stated goal is to foster a “virtuous cycle” of rising wages and sustained inflation.
Wages and Prices Remain Key Focus
The central bank said it was “highly likely” that companies will continue raising wages next year. That expectation follows solid pay increases recorded in 2025.
According to the BOJ, underlying inflation is rising at a moderate pace. Firms are increasingly passing higher labour costs on to consumers through price hikes.
Inflation has now stayed above the BOJ’s 2 per cent target for 44 consecutive months. Data released earlier on Friday showed consumer prices rose 2.9 per cent in November.
Cost-of-living Pressures Intensify
While inflation has remained elevated, real wages have been under pressure. Labour ministry data shows real wages have declined for 10 straight months.
That squeeze on household incomes has heightened concerns about living costs. It has also complicated the central bank’s efforts to balance inflation control with economic growth.
Higher interest rates could worsen those pressures if growth slows further.
Economic Growth Already Under Strain
Revised figures for the third quarter showed Japan’s economy shrank more than initially estimated. Gross domestic product contracted 0.6 per cent quarter on quarter, or 2.3 per cent on an annualised basis.
The rate hike also comes as Japanese government bond yields hover near multi-decade highs. Rising yields increase borrowing costs and add pressure to public finances.
Japan already carries the world’s highest debt-to-GDP ratio among major economies, at nearly 230 per cent, according to the International Monetary Fund.
Yen Weakness Adds Urgency
Currency movements have also shaped policy decisions. The yen has traded between 154 and 157 against the US dollar since November.
It has weakened more than 2.5 per cent since Prime Minister Sanae Takaichi took office in October. Takaichi is known for favouring looser monetary policy.
Economists say yen weakness has raised the urgency of tackling inflation and import-driven price pressures.
What Comes Next for Rates
Looking ahead, analysts expect one more hike. Oxford Economics’ Shigeto Nagai said the BOJ is likely to raise rates again by mid-2026, taking the policy rate to a terminal level of 1 per cent.
The terminal rate is considered neutral. It neither stimulates nor restricts economic growth.
BOJ Governor Kazuo Ueda has cautioned that estimating that level is difficult. The central bank currently places it somewhere between 1 per cent and 2.5 per cent.
Political Balancing Act Ahead
Nagai warned that further tightening could create friction with Prime Minister Takaichi. That risk would grow if inflation eases smoothly toward 2 per cent in early 2026.
Takaichi previously opposed rate hikes but has softened her stance. Analysts say the weak yen and cost-of-living concerns have reshaped her priorities.
In November, Japan’s cabinet approved a 21.3 trillion yen stimulus package. The measures aim to revive the slowing economy and support households hit by rising prices.
For now, the BOJ is pressing ahead carefully. Its challenge remains walking the fine line between taming inflation and avoiding deeper economic pain.
