In a significant move, the Bank of Japan (BOJ) raised its key interest rate to around 0.5% from 0.25%, marking the first such hike in 17 years. This decision reflects a steady recovery in Japan’s economy, fueled by higher wages and inflation holding steady at the central bank’s target level.

Governor Kazuo Ueda confirmed the rate increase, pointing to a positive economic cycle driven by rising prices and wages, alongside an economy that’s gradually rebounding. Despite uncertainties, including global inflation and currency fluctuations, Ueda affirmed that additional hikes may be necessary if economic conditions persist.

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Consumer prices in Japan have remained above the BOJ’s 2% target, with inflation reaching 2.5% for the third consecutive year, and a 3% rise in December alone. Wage growth has also contributed to the bank’s decision, with Japanese workers set to see notable pay raises in upcoming union negotiations.

Though stock markets reacted with an initial dip, the Nikkei 225 index stabilized, ending the day with minimal changes. The Japanese yen saw a slight dip against the U.S. dollar, trading at 155.41 yen per dollar.

Japan’s stance on interest rates contrasts with the approaches of the U.S. Federal Reserve and the European Central Bank, both of which have been cutting rates to manage inflation. Japan, however, remains focused on combating deflation and encouraging economic growth after years of ultra-loose monetary policies.

Analysts, such as Dilin Wu from Pepperstone, attribute this rate hike to Japan’s labor shortages and expectations of a 5% wage increase in 2025. With no aggressive trade protectionism from the U.S. under President Donald Trump, the economic environment has remained stable, supporting the BOJ’s decision to tighten its policies.

Looking ahead, the Bank of Japan expects the economy to continue growing at a robust pace in January, but it remains vigilant about factors that could affect inflation and economic activity, including global commodity prices and the domestic price-wage cycle. For fiscal year 2024, the BOJ anticipates a CPI increase of 2.5% to 3%, with inflation expected to stabilize at around 2% by fiscal year 2026.