Japan Raises Policy Rate to Highest Since 1995

The Bank of Japan kept its short-term policy rate unchanged at 1.0% at its July 2026 meeting, leaving borrowing costs at their highest level since September 1995 after raising the rate by 25bps in June, as the board warned that underlying inflation could exceed the 2% target. The widely expected decision passed by an 8-1 vote, with board member Hajime Takata dissenting and calling for a hike to 1.25%. Policymakers judged risks to economic activity to be broadly balanced, while noting the need to watch the impact of global AI-related demand and FX movements. In its quarterly outlook, the BoJ cut its FY2026 inflation forecast to 2.5% from 2.8%, reflecting government steps to ease households' summer energy costs. Meantime, policymakers slightly raised their FY2026 GDP growth projection to 0.6% from 0.5%, amid resilient domestic demand and continued support measures. For FY2027, the BoJ lifted its inflation forecast to 2.4% from 2.3%, while raising its GDP growth outlook to 0.8% from 0.7%.

Bank of Japan should continue raising interest rates at intervals of a few months, board member Naoki Tamura said in a speech, arguing the policy rate should gradually move toward a neutral level of around 2%, above the current 1%. He noted inflationary pressures are likely to strengthen regardless of Middle East tensions, with higher import costs expected to pass through to consumer prices more quickly and broadly than after Russia’s 2022 invasion of Ukraine, reflecting shifts in firms’ pricing behavior. “Considering the recent increase in upside risks to prices, what I envisage as a baseline path is raising the policy interest rate by 0.25 percentage points at intervals of a few months toward the neutral interest rate level of 2%,” Tamura said. He added that if inflation risks intensify, the central bank should “accelerate the pace of rate hikes without hesitation” by increasing either the frequency or size of moves.

The Bank of Japan’s June Summary of Opinions indicated broad support among policymakers for continuing rate hikes, citing underlying inflation moving closer to the 2% target while financial conditions remain accommodative. Members said that if the economy and prices evolve in line with the Bank's outlook, further rate hikes would be warranted. Some argued Japan's policy rate remains below the estimated neutral interest rate, seen at around 2%, and should be brought closer to that level to provide greater flexibility to adjust policy in either direction. They also suggested that gradual increases every few months could help avoid the need for more rapid and aggressive tightening later. However, one member cautioned that higher interest rates could curb business investment, weaken aggregate demand, and trigger simultaneous declines in inflation, production, and employment, arguing the board should keep rates unchanged for now.