Japan raises interest rates for second time since 2007

TOKYO – For only the second time in nearly two decades, Japan’s central bank on July 31 raised interest rates, a move that could help bolster the country’s ailing currency and ease the burden of consumers paying more for imported essentials like food and energy.

The Japanese central bank increased its target policy rate to 0.25 per cent, up from a range of zero per cent to 0.1 per cent. The rate was last bumped up in March, when the bank raised interest rates for the first time since 2007.

The large gap between interest rates in Japan and the United States has caused the yen to fall in value against the dollar over the past two years, but it regained some strength recently as traders anticipated an imminent rate increase from the Bank of Japan (BOJ).

The BOJ’s decision was being closely watched by investors and economists inside and outside of Japan. There are indications that the slack yen is holding back the spending power of Japanese consumers, and Japan’s economy, the world’s fourth largest, has shrunk in two of the past three quarters.

With inflation having exceeded policymakers’ target of 2 per cent for more than two years, analysts and economists widely expected at least one additional rate increase in 2024. But the increase to 0.25 per cent announced on July 31 was a particularly notable departure for the BOJ.

The bank has faced growing pressure to raise rates to prevent the yen – recently trading at its lowest against the dollar in decades – from sliding further.

Japan’s historically low interest rates – part of policies meant to encourage inflation during long periods when prices were barely growing – have been a main factor in the yen’s weakness, as low rates have pushed some investors to seek higher returns outside the country.

The weakened yen has effectively bifurcated Japan’s economy: Large international corporations have benefited, while consumers and smaller domestic businesses have been squeezed. But warning signals flashed about diminished domestic consumption, and Japan has spent tens of billions of dollars in 2024 buying yen to stabilise the currency.

Earlier in July, Mr Toshimitsu Motegi, a senior official with Japan’s governing party, said the BOJ needed to make clearer that it is willing to gradually raise interest rates. “An excessively weak yen is clearly negative for the Japanese economy,” he told the Nikkei newspaper.

The bank also issued plans on July 31 to halve its government bond purchases – now worth around six trillion yen, equivalent to US$39 billion (S$53 billion), every month – by the first quarter of 2026.

This was a key part of its work to return the country to more conventional policies, after years of aggressively buying bonds to stimulate economic demand.

The yen was trading at around 153 to the dollar after the BOJ’s announcement. That was slightly stronger than it was earlier this week and considerably stronger than at the beginning of the month when it was at 161 yen to the dollar.

Over the past two decades, policymakers in Japan had largely aimed to stimulate the economy by raising inflation and keeping the yen weak.

A devalued currency inflates the earnings of Japan’s big exporters and makes Japanese products more competitively priced abroad.

That remained the case in recent years. Companies like Toyota have reported some of the largest profits in Japanese history, thanks to the weakened yen, and Japan’s Nikkei 225 index, which features many export-driven companies, hit a series of record highs in 2024.

For consumers, however, the yen’s decline has exacerbated already high prices, making imports such as food and fuel more expensive. Rising costs and the expectation of continued high prices have led consumers to cut back on spending. Smaller businesses have been squeezed by both reduced demand and increased costs.

While the rate increase could make things like mortgages more expensive, economists said it should have an overall positive impact on consumer spending.

That is because of growing evidence that consumers are highly sensitive to fears that Japan’s weak yen will keep inflation persistently high.

“Benefits from a weak yen? That doesn’t exist around here,” said Mr Hiroshi Enomoto, the owner of a half-century-old shop in Tokyo selling traditional Japanese fish-shaped waffles called Taiyaki.

Mr Enomoto, 70, said that over the past few years, he has paid more for flour, largely bought from overseas, and for the gas he uses to heat his stove.

In addition to the cost increases, Mr Enomoto noted that customers were cutting back. “People used to buy them in tens to share with neighbours, or as souvenirs. Now it’s one or two,” he said.

In a report in June, economists at Mizuho Research & Technologies urged the Japanese government and the central bank to take action to support the yen, noting that its decline had widened the gap between profits accrued by large and small companies in Japan.

The report warned that smaller firms had been driven out of business by the weak yen, and those that survived have struggled to raise wages in a way that would stimulate consumption. “This is not desirable from the perspective of medium- to long-term economic growth,” it concluded.

There is some doubt about how much a rate increase could ultimately aid the yen, but the BOJ can help close the interest rate gap between the United States and Japan while waiting for the US Federal Reserve to cut its own rates, said Barclays chief Japan economist Naohiko Baba.

Inflation measures in the United States indicate that the Federal Reserve may be on track for a rate cut later in 2024, but probably not at its meeting on July 31.

“At the end of the day, the US side of the equation matters the most,” Mr Baba said. “What the BOJ can do is buy time.” NYTIMES