Japan’s central bank on Friday raised the benchmark interest rate to 1.25% from 1.0%, a 31-year-high.

After decades of keeping interest rates near or below zero to encourage more borrowing and spending, in an effort to counter deflation and pull Japan's economy out of the doldrums, the Bank of Japan has been trying to normalize monetary policy.

The rate increase in the uncollateralized overnight call rate, a short-term rate, was anticipated once the two-day monetary policy board meeting ended and had been widely factored into recent global markets.

Bank of Japan Governor Kazuo Ueda stated that the decision had been reached following an assessment of various risks, including the conflict in Iran, the growing market demand for artificial intelligence, and currency fluctuations.

"The Japanese economy is continuing to recover gradually," he told reporters, while noting inflation was close to the targeted 2%.

Analysts have suggested that a further increase could materialise later this year or in early next year.

When questioned regarding additional hikes, Ueda emphasised that more time is required to ascertain whether price increases remain stable, in addition to the need to monitor wage growth and other risk factors.

Two of the nine-member board dissented, voicing apprehensions regarding the robustness of Japan’s economic growth, according to Ueda.

The U.S. Federal Reserve likewise raised its key rate this week.

Wednesday's increase by the United States, the first since 2023, was enacted in an effort to quell stubbornly high inflation.

The United States has also been pressuring Japan to raise interest rates, driven by concerns about the weakening yen.

Recently, several nations intervened jointly to support the yen.

Despite the Bank of Japan's action, the U.S. dollar strengthened, briefly exceeding 157 yen.

Earlier this year, it had risen above 160 yen.

The Bank of Japan has established an inflation target of approximately 2%.

Inflation in Japan currently hovers around that level, though some consumers contend that the recent escalation in prices—particularly for gas and oil-related products—is excessive.

“With crude oil prices staying high, the Bank of Japan is expected to carry out another rate hike soon, in order to reduce the risk that consumer inflation exceeds the underlying inflation rate,” said Harumi Taguchi, an economist at S&P Global Market Intelligence.

Higher rates may also weigh on the economy, given the heavier borrowing costs for small and medium-sized enterprises, as well as higher mortgages, she added.

Analysts are also concerned about the ambitious public spending promised by Prime Minister Sanae Takaichi's government, such as tax cuts and significant defence investments, at a time when public debt is already rising sharply.

Tokyo’s benchmark Nikkei 225 climbed following the announcement of the Bank of Japan’s decision, inching up 1.4%.

Yuri Kageyama maintains a presence on Threads, accessible at https://www.threads.com/@yurikageyama