The Bank of Japan's nine-member board decided in a 7 to 2 vote to raise the overnight interest rate target to 0.25 percent from a range of 0 percent to 0.1 percent, citing gradually rising inflation expectations among households and businesses and high but slightly easing uncertainties for the economy. It also warned of upside risks to its GDP and CPI forecasts, specifically pointing out that the impact of currency market fluctuations on domestic prices is greater than in the past now that more firms are reflecting higher costs in prices and raising wages amid widespread labor shortages.

Since the short-term rate is close to zero, the bank noted that monetary conditions in Japan are expected to remain accommodative for now when adjusted for inflation.

If growth and inflation evolve around the bank's medium-term forecasts provided in its quarterly Outlook Report for July, the bank will"continue raising the policy interest rate and adjust the degree of monetary accommodation." The board left its policy stance steady at the last two meetings after conducting its first rate hike in 17 years and ending the seven-year-old yield curve control framework in a 7 to 2 vote in March.

The board decided in a unanimous vote to start reducing the pace of its purchases of Japanese government bonds (JGBs) gradually to around ¥3 trillion in the January-March quarter of 2026 from about ¥6 trillion now. In principle, it will reduce the pace by roughly ¥400 billion every quarter. At its June meeting, the board voted 8 to 1 to set the stage for gradually reducing the bank's large holdings of various financial assets and decide on special plans at the July meeting after consulting market participants.

BoJ officials are trying to ensure that price increases will be accompanied by sustained wage hikes in coming years. That's why they quote their own estimate for"underlying inflation," which has been slow to rise due to weak services prices which are closely tied to wage growth. Government officials still warned that the economy, despite increases in goods and materials prices, has not completely recovered from decades of deflation.

The BoJ has been under pressure from some politicians to raise rates to help turn around the protracted depreciation of the yen that has kept import costs high, one of many reasons for sluggish voter support for the Kishida administration that has been rocked by the political donation scandal at his ruling party. But for the currency to post a sustained recovery against the dollar, the wide gap in interest rates between the US and Japan must narrow significantly.

Earlier this month, the dollar hit a fresh 38-year high above ¥161.70 but it has eased to around ¥154 on suspected stealth yen-buying invention on July 11 and 12 by the Ministry of Finance, which appeared to have taken advantage of the US CPI data for June that showed easing inflation. The data prompted some dollar selling on the notion that the Federal Reserve may lower interest rates in September.

The Bank of Japan board is widely expected to maintain its policy stance at its two-day meeting on July 30-31 (there are some expectations for a split vote) and wait until its next meeting on Sept. 20-21 to follow up on its first rate hike in 17 years in March by raising the overnight interest rate target to 0.25 percent from the current range of zero to 0.1 percent. Governor Kazuo Ueda has said underlying inflation estimated by the bank is moving up but still below its 2 percent target. The Tokyo CPI data for July showed a slower rise in services costs, indicating the fastest wage hikes in 33 years at large firms have not yet spread to small businesses which employ about 70 percent of the workforce.

The board is scheduled to decide at its July meeting on how fast it should reduce the size of its purchases of Japanese government bonds over a year to two years as part of its policy normalization process. It is expected to slow the pace of monthly JGB purchases to about ¥3 trillion to ¥4 trillion from about ¥6 trillion.

The Bank of Japan is the central bank of Japan. The Bank of Japan Act states that the bank's monetary policy should be aimed at"achieving price stability, thereby contributing to the sound development of the national economy." The nine-member policy board reviews economic conditions at home and abroad before making a policy decision. There is no specific time for the announcement. The board holds eight two-day Monetary Policy Meetings a year, in January, March, April, June, July, September, October and December. At each meeting, the board votes on the proposals on the bank’s monetary policy stance and the basic guideline on how to achieve the policy target submitted by the chair of the board, who is the bank governor.

The announcement of the bank’s monetary policy decision after each meeting can cause a market reaction, even when there is no change to the policy stance. Markets tend to look ahead toward a policy shift, pricing in a change to the bank’s targets for overnight and long-term interest rates, the pace of financial asset purchases or the scale of market operations.

Market participants closely monitor the news conference by the BoJ governor that usually starts at 1530 JST (0130 EST/0230 EDT/0630 GMT), a few hours after the bank releases its policy decision. Comments from the governor could provide clues to what the bank may or may not do in the near term, which in turn could trigger buying or selling of the yen against the dollar.

Since April 2023, the bank has been conducting a"broad-perspective review" of the costs and benefits of its various monetary easing measures implemented in the past 25 years. The negative overnight interest rate target introduced in January 2016 has been unpopular among lenders as it squeezes their profit margins.