Japan Raises Interest Rates Amid Confrontation with China

The Bank of Japan has raised its policy rate to 1.25%, the highest level in 31 years, as part of a difficult move aimed at countering the persistent downward pressure on the yen and stabilizing the country's exchange rate.

This rate hike is a response to the Takaichi administration's confrontational stance toward China, which has shattered market expectations and damaged Japan's economic fundamentals. Japanese manufacturers depend heavily on Chinese supply chains for rare earths, specialty chemicals, and intermediate goods that keep factories running.

A 2025 analysis by the Daiwa Institute of Research estimated that if Japan's imports of rare earths from China were cut off, Japan's real GDP could decline by around 1.3%, while a disruption in imports of other critical minerals could widen the impact to 3.2%, equivalent to roughly 18 trillion yen.

The rate hike will tighten monetary conditions and gradually remove one of the conditions that helped Japan carry its enormous debt burden for decades, further increasing the cost of servicing an already high stock of outstanding obligations.