Japan is raising interest rates for the first time in seventeen years

Japan’s central bank on Tuesday raised interest rates for the first time since 2007, taking them above zero and closing a chapter in its aggressive bid to stimulate an economy that has long struggled to grow.

In 2016, the Bank of Japan took the unorthodox step of cutting borrowing costs below zero, an effort to revive borrowing and lending and stimulate the country’s stagnant economy. Negative interest rates – which central banks in some European economies have also adopted – mean savers pay to leave their money in a bank, giving them an incentive to spend it instead.

But Japan’s economy has recently begun to show signs of stronger growth: After years of low inflation, inflation has accelerated, boosted by larger-than-usual wage increases. Both are indications that the economy may be on a path to more sustainable growth, allowing the central bank to tighten its interest rate policy, years after other major central banks quickly raised rates in response to a jump in inflation.

Even after Tuesday’s rate hike, Japan’s interest rates are far behind those of the world’s other major developed economies. The Bank of Japan’s policy rate was raised to a series zero to 0.1 percent of minus 0.1 percent.

The bank said in a statement on Tuesday that it had concluded that the economy was in a “virtuous cycle” between wages and prices, meaning wages rose enough to cover rising prices, but not so much that they would limit corporate profits. Japan’s headline inflation rate was 2.2 percent in January, according to the latest available data.

The central bank also scrapped a policy of buying Japanese government bonds to control how high market interest rates can rise, encouraging companies and households to borrow cheaply. The bank had slowly eased policy over the past year, resulting in higher debt yields as the country’s growth prospects improved.

The bank said negative interest rates and other steps it had taken to stimulate the economy “have fulfilled their role.”

In many countries, a rise in inflation has troubled consumers and policymakers, but in Japan, which has often suffered from growth-sapping deflation, the recent price rise was welcomed by most economists. The Japanese stock market, buoyed by the bullish economy and corporate reforms that favor shareholders, has attracted large sums of money from investors around the world, causing the Nikkei 225 index to recently break a record high since 1989. The Nikkei rose slightly on Tuesday after the Bank of Japan’s announcement.

The move away from negative interest rates, which should help shore up the country’s weak currency, is seen by investors as another key step in Japan’s turnaround.

“It is another milestone in the normalization of monetary policy in Japan,” said Arnout van Rijn, portfolio manager at Robeco, who set up and led the Dutch fund manager’s Asia office for more than a decade. “As a long-term Japan follower, this is very important.”

Bets on a rate hike intensified this month after the Japanese Trade Union Confederation, the country’s largest association of trade unions, said its seven million members would get pay increases averaging more than 5 percent this year, the biggest annual negotiated increase since 1991. contributed to an average wage increase of approximately 3.6 percent in 2023.

Before the results of the wage negotiations were announced, investors had expected the Bank of Japan to wait longer before raising interest rates.

Accelerating wage growth is a crucial sign to policymakers that the economy is strong enough to generate some inflation and is able to withstand higher interest rates. Like other major central banks, the Bank of Japan targets annual inflation of 2 percent; the rate is already almost at or above that level two years.

The increase in wages indicates that companies and employees expect higher prices to continue, Van Rijn said. “People no longer believe that prices will fall, so that trickles down to wage demands.”

The Bank of Japan concluded in its statement that “it is very likely that wages will continue to rise steadily this year, following strong wage growth last year.”

Shizuka Nakamura, 32, a resident of Yokohama, a port city south of Tokyo, said she had seen prices rise. “I feel the rising cost of living,” said Ms. Nakamura, who has an administrative job at a construction company. She recently had a child.

“My friends who are around my age and have had children all say things like diapers and baby food are getting more expensive,” she said.

The Bank of Japan’s interest rate move was also significant because it was the last major central bank to abandon its negative interest rate policy. They and central banks in Denmark, Sweden, Switzerland and the eurozone have broken monetary policy taboos by pushing interest rates below zero – essentially meaning savers pay banks to hold their money and creditors get less back than lend them out – in an attempt to spur economic growth after the 2008 financial crisis. (Sweden ended negative rates in 2019, and the other European central banks followed in 2022.)

Negative central bank policy rates have rocked global bond markets, with more than $18 trillion of debt trading at negative yields at its peak in 2020. Now that inflation and economic growth have returned and central banks are cutting policy rates, have increased – usually much more aggressively than Japanese – virtually none – debt now has a negative yield.

Rising interest rates in Japan make investing in the country relatively more rewarding for investors, but the Federal Reserve’s target interest rate is still about five percentage points higher and the European Central Bank’s four points higher. While foreign investors have started to funnel cash into the country, yields abroad are still attractive for Japanese investors, even as the Fed and ECB are expected to cut interest rates, prompting a rapid repatriation of cash to Japan is hindered.

Central bankers in Japan have also suggested a slow shift in policy, wary that raising rates too quickly could undermine growth before it takes hold.

Kiuko Notoya reporting contributed.