BOJ Raises Benchmark Rate to 1% for First Time in 31 Years; No Yen Carry Unwind

The Bank of Japan raised its benchmark interest rate to 1.0% from 0.75% at a monetary policy meeting on June 16, delivering its first increase in six months since December. Japan’s policy rate has reached the 1% level for the first time since 1995.

In a statement issued after the decision, the BOJ said it would continue raising the policy rate and adjust the degree of monetary easing in line with economic activity, prices and financial conditions, signaling scope for further increases. Japan has been lifting rates gradually since ending its negative interest-rate policy in March 2024.

The move was driven in part by yen weakness and mounting price pressure. Japan’s corporate goods price index rose 6.3% in May from a year earlier, the fastest pace in three years and two months. The outbreak of war between the US and Iran pushed up global oil prices, increasing pressure from import costs and strengthening the case for a preemptive response to inflation. The interest-rate gap with the US and the Japanese government’s expansionary fiscal stance also contributed to the yen’s weakness.

A feared unwind in the yen carry trade did not materialize. The Nikkei 225 rose above 70,000 for the first time ever during trading on June 16. South Korea’s Kospi gained 2.11%, while Taiwan’s Taiex added 0.91%. Demand for the yen carry trade remains intact because Japan’s policy rate is still low compared with those of other major economies. Sumitomo Mitsui DS Asset Management said markets had already accepted Japan’s move into the 1% rate range as a foregone conclusion, leaving equities largely unaffected.

Other economies are also moving toward tighter policy. The European Central Bank raised its policy rate to 2.25% on June 11, marking a return to tightening for the first time in about three years.

Inflation Fight Intensifies After War Ends as Rate-Hike Domino Begins

Central Banks End Easy Money; Japan Reaches 1% for First Time in 31 Years

Major central banks including the BOJ and the ECB are raising benchmark rates in succession. Countries that had focused on cushioning economic slowdowns earlier this year are now shifting toward inflation control as a war-driven oil shock becomes reality. Even after the end of the Iran war, crude prices are expected to take considerable time to return to prewar levels, suggesting the tightening cycle may continue for now.

◇ "Fed May Raise Rates Three Times This Year"

The BOJ, which raised its benchmark rate by 0.25 percentage point on June 16, said the move could eventually lead to broad-based increases in consumer goods prices, underscoring its concern over inflation. Markets put the lower bound of Japan’s neutral rate at around 1.5%. The neutral rate is the level that neither stimulates nor restrains the economy. Nomura Securities said the BOJ would raise rates by 0.25 percentage point every six months, including this increase, until the policy rate reaches 1.5%.

Central banks elsewhere have also begun lifting rates in quick succession. The Reserve Bank of Australia has moved faster than many peers, raising rates three times this year and taking the benchmark rate to 4.35% since May. The ECB also raised its deposit rate by 0.25 percentage point to 2.25% from 2.0% on June 11, shifting to a tightening stance for the first time in about three years. The move followed euro-area inflation above 3% in May from a year earlier across the 21 countries that use the euro.

ECB President Christine Lagarde told reporters the Middle East conflict had lasted longer than expected and was causing a major energy shock. The need for a rate increase was therefore very clear.

The Federal Reserve has kept its benchmark rate at 3.50% to 7.75% this year. The central bank is expected to leave rates unchanged at Chair Kevin Warsh’s first Federal Open Market Committee meeting on June 17. Still, expectations for later increases are gaining traction after US consumer prices rose 4.2% in May from a year earlier, topping 4% for the first time in three years.

PGIM said in a recent report that the Fed would raise rates three times this year to reinforce institutional credibility and keep inflation expectations anchored.

◇ Hormuz Normalization Is the Key Variable

The starting point for the rate-hike debate is the energy shock emanating from the Middle East. Since February, the Iran war and instability in the Strait of Hormuz have driven up not only crude oil prices but also naphtha prices and shipping costs. Central banks are concerned about second-round effects as higher production costs spread through to broader consumer prices.

James Knightley, ING’s chief international economist, said average US gasoline prices would not fall back below the prewar level of $3 a gallon, and inflation would not return to the Fed’s 2% target, until 2027. Bundesbank President Joachim Nagel said some production facilities in the Middle East had been damaged or shut down and stockpiles had also fallen. Even if shipping through the Strait of Hormuz resumes, he added, oil supply will take months to normalize.

Import-dependent economies including South Korea, Japan and Australia are considering rate increases to defend their currencies. A weaker currency raises import costs for crude oil, grain and other goods, which can then feed into broader inflation.

For that reason, the timing of normalization in the Strait of Hormuz is a key variable that could change the path of central-bank rates. If shipping recovers quickly and oil stays near $80 a barrel, the pace of tightening could ease somewhat. CME FedWatch data show the probability of a US rate increase by December at 50%, down sharply from more than 70% before ceasefire negotiations were reached.

Kim Dong-hyun / Tokyo correspondent Choi Man-su 3code@hankyung.com