The Bank of Japan raises rates to 1.25%—and the yen still weakens

The Bank of Japan raised its policy rate by 0.25 percentage points to 1.25%, the highest since 1995. The decision passed 7–2 as the bank warned that inflation could overshoot its 2% target.

Japan is leaving a long period of ultra-loose policy under difficult conditions. A weak yen raises the local cost of imported energy and food, while the Middle East conflict has intensified oil-price pressure. The move also follows a rare US–Japan currency intervention and the Federal Reserve’s first rate increase since 2023.

Yet the yen weakened past ¥157 to the dollar after the decision. Markets focused on two dissenting board members and the absence of an explicit commitment to rapid further increases. Japanese equities rose and bond yields eased, a combination suggesting investors heard a rate rise without a much tighter path.

That reaction illustrates the central bank’s communication trap. Moving too slowly can weaken the currency and import more inflation; sounding too aggressive can destabilize a bond market financing government debt above 250% of GDP. At 1.25%, policy is only entering the Bank’s estimated neutral range rather than becoming conventionally restrictive.

Economists surveyed by Reuters expect 1.5% by March and 1.75% in the second quarter of 2027, but the path will depend on wages, oil and the yen. The rate itself is historic for Japan; the market’s response says that normalization is still judged by what comes next.