The Bank of Japan raised interest rates to a 31-year high on Tuesday, marking another landmark step in normalising monetary policy as it focused on taming price pressures from the energy shock caused by the Iran war.
The hike was the first since December and aligns the BOJ with other central banks shifting towards tighter policy to combat inflation, including the European Central Bank.
In a widely expected move, the BOJ decided to raise its short-term policy rate to 1% from 0.75%, taking borrowing costs to levels unseen since 1995.
In a statement announcing the decision, the BOJ said the risk of Japan's economy deteriorating sharply from the Middle East conflict has diminished due to government steps to curb households' burden from high fuel costs and progress made in procuring alternative energy supplies.
The price outlook, on the other hand, warranted attention as companies were seen passing on rising oil costs to each other at a "relatively fast pace," which could push up consumer prices across a wide range of items, it said.
"Taking into account that medium- and long-term inflation expectations have also continued to increase, there is a risk of underlying inflation deviating above our price target," the BOJ said.
The decision was made by a 7-1 vote. Governor Kazuo Ueda missed the meeting and did not vote due to a two-week treatment in hospital for an infected liver cyst.
Toichiro Asada, who joined the board in April as the first member to be hand-picked by dovish premier Sanae Takaichi, dissented on the view downside risks to growth from the Middle East conflict were bigger than inflation risks.
"If anything, the focus had been on whether a 50-bp rate hike would be proposed, but no such proposal was made. In terms of the future rate-hike path, this is positive for risk asset prices, as it suggests that a sharp rate hike is likely to be avoided," said Hirofumi Suzuki, chief FX strategist at SMBC.
"The BOJ is likely to continue raising rates at a gradual pace of around once every six months to one year," he said.
The Nikkei 225 (.N225), jumped as much as 1% to set a fresh record high above 70,000 after the announcement. The yen rose 0.1% to 160.215 against the dollar, while the yield on the benchmark 10-year JGB was up 3.5 basis points at 2.61%.
The BOJ also decided to pause its bond taper programme from April next year and continue to buy roughly 2 trillion yen ($12.5 billion) in Japanese government bonds (JGB) per month.
It will discontinue its practice of conducting a review of its bond taper plan each year, but stand ready to amend the pace of purchases if necessary at future policy meetings.
SPOTLIGHT ON UCHIDA
All eyes will be on any hints Deputy Governor Shinichi Uchida could drop on the pace and timing of future rate hikes at a news briefing he will hold on behalf of Ueda.
"I expect a hawkish message today. But the BOJ seems intent on avoiding saying anything that could be taken as a firm commitment, so I do not think it will provide many concrete hints," said Masato Koike, senior economist at Sompo Institute Plus.
The Middle East conflict has complicated the BOJ's policy path by adding inflationary pressure through higher oil costs, while hurting an economy heavily reliant on imported fuel.
While the peace deal between the U.S. and Iran eased market fears over global inflationary pressures, wholesale inflation spiked to a 3-year high of 6.3% in May in a sign companies were already passing on higher costs from the energy shock.
Analysts expect core consumer inflation to accelerate back above the BOJ's 2% target later this year, after sliding below the level on government subsidies aimed at curbing utility bills.
The BOJ kept policy steady at its previous meeting in April but sharply revised up its price forecasts and stressed its vigilance to the risk of an inflation overshoot.
A flurry of hawkish BOJ signals since then led markets to almost fully price in the chance of a rate increase this month. A Reuters poll showed economists projecting the BOJ to raise rates to 1.25% in the fourth quarter after a hike in June to 1%.
A weak yen, which pushes up import prices and broader inflation, will also keep the BOJ under pressure to stay on course for further rate hikes, analysts say.
The BOJ's hike comes amid a busy week for global central banks.
The U.S. Federal Reserve is widely expected to hold its benchmark interest rate steady on Wednesday but officials have recently signaled their rising concern about inflation, which has led more in the market to now predict its next move as being a hike rather than a cut.
Source: Reuters
--Agencies
