The Bank of Japan announced the first interest rate hike in 17 years. Here’s what it means for Asia’s second-largest economy.
Japan ended its 17-year-long era of dovish interest rates, raising the cost of money for the first time since 2007. Japan is the world’s fourth-largest economy and the second-largest in Asia but has been struggling with stagnation and deflation for almost two decades.
Bank of Japan Governor Kazuo Ueda announced the widely expected decision on Tuesday, marking the last major central bank to raise interest rates amid global inflation. Japanese prices increased 2.2% year-on-year, above the BoJ’s 2% target.
Inflation has risen in the Asian nation since the Russian invasion of Ukraine. Although the price surge was less severe than in Europe or the United States, it still worried investors.
Moreover, Japan narrowly avoided a recession in early 2024. Initial GDP estimates showed a 0.4% contraction following a 3.3% decline in Q3 last year. A recession is technically reached with two consecutive quarters of GDP contraction.
A new revision however showed actual GDP growth of 0.4% in Q4, meaning Japan did not fall into a recession. However, it means Japan’s stagnation is not over either, and the measures taken by the central bank have not solved it.
At the start of the century, Japan was the world’s second-largest economy. It now officially lost two positions, falling behind China and Germany, because its GDP remained virtually the same.
Negative rates: a failed experiment
Trying to dig itself outside of stagnation, Japan implemented an innovative monetary policy: negative interest rates. Normally, interest rates are always above zero, meaning borrowers always have to pay interest on their loans.
By bringing interest rates below zero, the Bank of Japan was essentially charging for “holding” liquidity. It was a cost for banks and final consumers alike, understandably generating a lot of backlash.
The idea behind negative interest rates was to incentivize investments and the circulation of liquidity. This would in turn increase the nation’s economic output and GDP.
After Japan implemented negative interest rates in 2016, other major central banks followed suit, including those in Switzerland, Denmark, and the European Union.
The US Federal Reserve reportedly flirted with the idea of negative interest rates, but never actually implemented it.
Negative interest rates, however, never really achieved their goal. Japan’s economy remained stagnant, if anything adding a burden to the population.
With today’s decision to bring interest rates from -0.1% to 0.1%, Japan officially enters a new economic era. The future outlook, however, remains equally bleak.
