Japan's central bank decided on September 18th to lift its policy rate from 1% to 1.25%, marking the highest level since April 1995. The decision passed with a 7-2 vote. The Bank of Japan stated that underlying inflation is approaching its 2% target, and if economic and price trends align with projections, it will continue to raise rates and scale back monetary easing.

The new rate takes effect on September 24th. The Bank of Japan is increasing its target for unsecured overnight call rates from around 1% to approximately 1.25%, with the new rate becoming active on September 24th. This marks the second rate hike within three months and represents the shortest interval between increases since Kazuo Ueda assumed the governorship in 2023. Alongside this policy adjustment, the Bank of Japan is raising the interest rate on excess reserves held by financial institutions to 1.25% and lifting the basic loan rate under its complementary lending facility to 1.5%.

The Bank of Japan believes that Japan's financial conditions remain accommodative even after the hike, with real interest rates staying at low levels. Bank lending attitudes and corporate financing conditions continue to support economic activity.

Underlying inflation is approaching the 2% target. The Bank of Japan reports that the economy is experiencing a moderate recovery, with exports and industrial production beginning to grow. Corporate profits remain elevated, and private consumption stays resilient, supported by improvements in employment and income. On the price front, rising crude oil costs, yen depreciation, and expanding demand related to artificial intelligence are driving up corporate input expenses.

Companies are continuing to pass on wage growth to goods and service prices, and medium-to-long-term inflation expectations are also rising. Underlying inflation has now moved close to the 2% price stability target. The Bank of Japan projects that from the second half of fiscal 2026, the consumer price index excluding fresh food may clearly exceed 2%. As the impact of higher oil prices gradually fades, inflation is expected to settle back to around 2% in the latter half of the forecast period. The central bank also flagged that developments in the Middle East, global AI demand, and currency fluctuations could still alter Japan's economic and price trajectory, posing risks that underlying inflation could overshoot the 2% target.

Two board members opposed the rate increase. Members Uchiro Asada and Ayano Sato voted against the hike. Asada argued that recent consumer price growth excluding fresh food has been below 2% and that economic conditions cannot yet be considered robust enough, so the policy rate should remain at 1%. Sato contended that current economic and price momentum has not shown a clear acceleration from earlier levels, making this an unsuitable time for a rate increase.

Despite the two dissenting votes, the Bank of Japan maintained its forward-looking stance on further tightening. The central bank stated it will determine the timing and pace of future adjustments based on economic, price, and financial conditions, with a focus on preventing underlying inflation from persistently exceeding its target. On the same day, the Nikkei 225 index rose approximately 1.4%.