Japan raises interest rates to 31-year high to curb impact of rising prices

Japan's central bank, the Bank of Japan (BoJ), has raised its interest rate to a 31-year high of 1.25% in an effort to tackle the effects of soaring global inflation stemming from the Iran conflict. This move follows the lead of the US Federal Reserve and the European Central Bank, who have also increased monetary policy this month.

The BoJ's decision to raise its target interest rate from 1% to 1.25% marks the highest level since 1995. The policy shift aims to counteract the impact of inflation, which is being driven by the geopolitical tensions in the Middle East. The Bank of England had previously left UK interest rates unchanged at 3.75% but cautioned that further increases may be necessary due to the consequences of the Iran war.

The BoJ has been gradually increasing rates since 2024, when it lifted its base rate out of the negative territory it had been in for years. The bank has been under pressure to raise borrowing costs due to the yen's steady depreciation against the dollar this year, reaching levels that prompted policymakers to intervene to stabilize the currency. The Japanese currency weakened by approximately 0.7% against the dollar on Friday.

However, the decision to raise rates was not unanimous among the BoJ's board members, with two dissenting voices against the increase. Fred Neumann, HSBC's chief Asia economist, expressed doubts about the central bank's cautious approach to further tightening monetary policy. While a second consecutive rate hike appears unlikely, investors will be watching for signs of potential further rate hikes in December.

The weakening of the yen had a positive impact on Japan's stock market, with the Nikkei index surging nearly 2% following the rate hike announcement. Meanwhile, Japanese two-year government bond yields, which are most sensitive to monetary policy expectations, fell by four basis points to 1.82%.

European stock futures, on the other hand, slipped by 0.35%, indicating a lower opening. Prashant Newnaha, a senior rates strategist at TD Securities, reiterated that the BoJ has concerns that underlying inflation could rise above its 2% target. However, Newnaha does not see strong evidence supporting a back-to-back rate hike in October.

He maintained the bank's stance that rate hikes will occur roughly every quarter, with the next 25 basis points hike expected in December. The hopes for alternative methods to ensure oil supply from the Middle East reached markets helped Brent crude futures fall as much as 1.5% to $103.29 a barrel, despite lingering concerns about potential strikes between Saudi Arabia and Yemen's Houthis.