The central bank increased the rate by 0.25 percentage points during its final policy meeting of the year, marking another big step away from decades of ultra-easy money policy.
This move takes Japan’s key interest rate to a 30-year high and has the potential to impact global financial markets.
The decision was widely expected and had been clearly signalled by BOJ policymakers in recent weeks.
"Real interest rates are expected to remain significantly negative after the policy change, and accommodative financial conditions will continue to firmly support economic activity," the BOJ said.
The rate hike was approved unanimously and is the fourth increase since Governor Kazuo Ueda took charge of the central bank in 2023.
For many years, Japan kept interest rates at or below zero to fight deflation, even as major global central banks raised rates sharply after the Covid-19 pandemic.
However, rising inflation and improving business confidence have pushed the BOJ to change its stance, despite Japan’s economy shrinking at an annual rate of 2.3% in the last quarter.
The BOJ also said the decision was justified as it is “highly likely” that wages and prices will continue to rise at a moderate pace.
The Japanese yen weakened against the US dollar after the announcement, suggesting markets had already priced in the rate hike.
The yen fell more than 0.3 per cent to around 156.02 per dollar. The euro strengthened to 182.92 yen, while the British pound rose 0.3 per cent to 208.71 yen.
Japanese stock markets reacted positively to the decision. The benchmark Nikkei 225 jumped as much as 1.42 per cent following the announcement on Friday, as investors welcomed the clarity on the BOJ’s policy direction.
The latest hike is part of the BOJ’s broader effort to normalise monetary policy after years of massive stimulus and near-zero borrowing costs.
The central bank has also left the door open for further tightening beyond next year if inflation and wage growth continue to remain strong.
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