Japan interest rate change: what you should know

The Bank of Japan (BoJ) made a historic decision on July 31, 2024, by raising its key interest rate to 0.25% from around zero to 0.1%. This marked a significant departure from its ultra-loose monetary policy, which had been in place for nearly two decades.

What has happened so far?

Japan has been grappling with deflationary pressures for several years. In an attempt to stimulate economic growth and combat deflation, the BoJ adopted a negative interest rate policy in 2016. This meant that banks were charged for holding excess reserves with the central bank, incentivising them to lend more money to businesses and consumers.

However, despite years of ultra-loose monetary policy, Japan struggled to achieve its inflation target of 2%. While the economy avoided outright deflation, it remained stuck in a low-growth, low-inflation environment.

Why did Japan increase the interest rates?

Several factors contributed to the BoJ's decision to abandon its ultra-loose monetary policy:

• Yen Weakness: The Japanese yen had depreciated significantly against the US dollar, fueling inflation concerns.
• Global Inflationary Pressures: Rising inflation rates in other major economies prompted the BoJ to re-evaluate its monetary policy stance.
• Economic Recovery: The Japanese economy showed signs of improvement, reducing the need for ultra-loose monetary policy.

Impact of Japan interest rate hike

The BoJ's decision has far-reaching implications:

• Yen Strengthening: The rate hike led to a sharp appreciation of the Japanese yen against the US dollar. This could impact Japanese exporters and importers.
• Market Volatility: The unexpected move caused significant volatility in global financial markets, with stock prices initially declining before recovering.
• Domestic Economic Outlook: The impact of the rate hike on the Japanese economy will depend on how businesses and consumers respond to the change in borrowing costs.

Outlook for Japan’s economy

While the rate hike marks a significant shift in Japan's monetary policy, it's important to note that the central bank is still maintaining an accommodative stance. The BoJ has emphasised that the rate hike is a gradual adjustment and not the beginning of a tightening cycle.

The success of the rate hike in achieving BoJ's objectives of price stability and sustainable economic growth will depend on various factors, including global economic conditions, domestic consumption, and business investment.

The BoJ's decision to abandon its ultra-loose monetary policy is a watershed moment for the Japanese economy. The long-term implications of this shift will be closely watched by investors and policymakers around the world.