The Bank of Japan raised its benchmark interest rate on Tuesday by 0.25 percentage points to 1 percent, marking the highest level in 31 years. The move aims to curb inflationary pressures linked to rising energy costs caused by the ongoing conflict in the Middle East, particularly disruptions related to the Iran war.

The central bank’s decision reflects concerns over increasing crude oil prices and their pass-through effects on the broader economy. Inflation had shown signs of accelerating, with companies reportedly passing on higher oil costs at a relatively fast pace. Despite a recent drop in oil prices following a preliminary agreement between the United States and Iran to reopen the Strait of Hormuz, the Bank of Japan maintained that uncertainties remain regarding how quickly oil supplies might stabilize.

Deputy Governor Shinichi Uchida described the memorandum between Washington and Tehran as a positive development that reduced downside risks to the Japanese economy. However, he emphasized the persistence of inflationary risks, noting that underlying price increases were broadening and that the central bank must ensure inflation remains near its target level. Japan’s core inflation rate had fallen to 1.4 percent in April, its lowest in four years, but officials warned that price pressures could intensify in the months ahead due to supply chain disruptions and ongoing geopolitical tensions.

The rate hike follows a period of gradual tightening that began earlier in 2024, after decades of near-zero and even negative interest rates. The Bank of Japan’s move places it on a similar path as other major central banks, such as the European Central Bank, which has also raised rates quickly in response to recent global energy shocks. Economists suggest the Bank of Japan is aiming to preempt a repeat of last year’s inflation surge, which followed delayed rate increases by some central banks after Russia’s invasion of Ukraine.

This policy shift comes amid pressures on the Japanese yen, which has weakened significantly against the U.S. dollar, trading past 160 yen per dollar for the first time in nearly two years. A weaker yen has traditionally benefited Japanese exporters by making their goods less expensive overseas, but it has also increased import costs for fuel and other commodities. The Japanese finance ministry has intervened in currency markets to support the yen, yet with limited effect. Many analysts argue that higher interest rates and narrowing the gap with U.S. yields are necessary to stabilize the currency.

The economic and monetary policy environment also carries political implications. Prime Minister Sanae Takaichi, who took office last October, has advocated for policies favoring a weaker yen and low interest rates to boost exports and support her agenda of stimulus, tax cuts, and increased defense spending. Yet, economists note that growing external pressures, including warnings from U.S. Treasury officials, and the urgency of addressing inflationary risks leave the government with little choice but to accommodate the central bank’s rate increases despite political opposition.

Following the announcement, Japan’s benchmark Nikkei 225 index rose sharply before settling slightly higher, reflecting investor relief that the central bank moved decisively but without an unexpectedly large hike. Observers characterized the quarter-point increase as a significant shift in Japan’s long-standing monetary stance but pointed to continued uncertainty over future policy steps as the global economic landscape evolves.