Author: Yagiz Kokal
This article provides the background on Japan’s decades-long policy of near-zero and negative interest rates and explains why such a loose policy persisted for so long. Then it will examine the BOJ’s (Bank of Japan) decision to raise rates on the 19th of December 2025, the domestic conditions, and how markets reacted in Japan. Finally, it will explore international implications, from the reversal of the yen carry trade to shifts in global capital flows and bond markets.
Introduction
For over two decades, Japan maintained near-zero or negative interest rates as a part of its monetary strategy. After an asset bubble burst in the early 90s, the BOJ decreased interest rates drastically to encourage borrowing and spending. The move was not by choice or optional; Japan’s deflationary environment and aging demographic made these policies obligatory. By the mid-2010s, the Bank of Japan adopted a negative policy rate of -0.1% to boost the economy out of deflation. Massive quantitative easing (QE is a monetary policy action where a central bank purchases predetermined amounts of government bonds, shares, or other assets to artificially stimulate economic activity.) These measures helped manage the government’s huge debt (approximately 250% of GDP) by keeping debt-service costs low. They also highlighted the BOJ’s struggle to raise inflation to its 2% target.
Decades of really low interest rates in Japan
Deflation and weak growth: repeated economic slowdowns and price declines meant any increase in interest rates risked further slowing down the economy. Even with cheaper debt, private investment didn’t meet expectations, and growth stayed the same.
High public debt: low rates took a bit of the burden off from Japan’s public debt (the highest in the world as a percentage of GDP).
Aging population: Japan’s aging and shrinking population negatively impacted domestic demand and investment feasibility, which in turn lowered the economy’s growth and inflation potential.
External factors: Events like the global financial crisis and the COVID-19 pandemic pushed the BOJ to keep its monetary policy accommodative to support its economy. The economy experienced a delay in returning to normal rates. Even in 2020, policy rates remained negative.
Japan didn’t see a policy rate above 0.5% in 30 years. Major central banks abroad raised and lowered interest rates again, but Japan stayed the same. This situation began to change in late 2024, when the BOJ finally ended its long-coming low interest rate regime and started increasing rates as inflation became more lively.
The latest increase was the highest in 30 years.
On December 19, 2025, the BOJ raised its short-term policy rate from 0.50% to 0.75%, the highest level since 1995 and its third increase within a year. Although a 25-point increase is modest and might look small, it is historically significant for Japan, as it marks the clearest move away from decades of super cheap debt policy. The policy board unanimously approved the widely anticipated decision. The BOJ justified the increase by saying that it increased confidence to reach the 2% inflation target while sustaining rising wages and stable demand. Despite the increase, authorities stated that real interest rates remain negative as inflation is still around 3% (3% inflation – 0.75% rate = real interest rate -2.25%), meaning monetary conditions are still quite accommodative. The Central Bank implied that further rate increases are likely if economic conditions continue to move as expected.
Domestic context
Japan is experiencing its most persistent and strong inflation in decades. CPI (consumer price index) has been above the 2% target for over four years. In November 2025, inflation hit 3%, well above target. Unlike in the past, price gains now show signs of opening and broadening. High food and import prices (partly due to earlier yen weakness) have kept inflation elevated. The IMF noted in early 2025 that Japan appeared to be sustainably achieving 2% inflation after “three decades of near-zero inflation.” Moreover, wages are finally rising alongside prices. Japan’s labor market is operating at full capacity thanks to demographic constraints and a rebound in demand.
Market reactions in Japan
Japanese government bond yields increased in response to the rate increase. The benchmark 10-year Japanese Government Bond (JGB) jumped to around 2.0%, the highest since August 1999. In fact, 10-year yields hit about 2.015%, which breaks Japan’s deflationary environment. Shorter maturities also saw yields climb; the 2-year yield rose to 1.085%, the highest since 2007, and 5-year saw 1.47%, the highest since 2008. These moves reflect that BOJ’s normalization policies are working. Furthermore, Japanese equities welcomed the rate increase as a sign of economic strength. The Nikkei 225 index rose about 0.9% on the day of the decision, even as the yen weakened. Banks got a lift from prospects of improved lending margins in a higher-rate environment. The broader TOPIX index also climbed around 0.7%.
International implications:
For years, Japan’s low rates encouraged foreigners to do the “yen carry trade,” where foreign investors borrow cheap yen to invest in higher-yielding assets abroad. This strategy caused the allocation of Japanese savings to U.S. Treasury bonds, global stocks, emerging market bonds, and even speculative instruments like cryptocurrencies. With Japanese rates rising and U.S./European rates stabilizing or falling, the calculus for the carry trade is shifting. Higher yen interest costs and a potentially stronger yen reduce the appeal of borrowing it. As interest rate differences between Japan and other advanced economies narrow, capital flows may shift back to Japan. Higher domestic bond yields could encourage Japanese institutional investors to reallocate their capital from foreign assets to JGB, while also attracting foreign investors seeking improved positive pressure on global yields and borrowing costs.
Conclusion
Japan’s December 2025 interest rate hike to 0.75% is a significant moment, closing the chapter on decades of zero and negative rates. The decision was underpinned by evidence that Japan’s economy may finally sustain moderate inflation with the help of rising wages, a scenario that policymakers and international observers (like the IMF) have awaited for years. Domestically, the BOJ faces the challenge of curbing inflation without derailing growth or destabilizing its heavily indebted financial system. Early market reactions at home, higher bond yields, a still weak yen, and steady equities suggest cautious optimism that the BOJ can manage a gradual normalization. Internationally, even a small increase in Japan reaches across borders: it signals the potential unwinding of longstanding carry trades and a rebalancing of global capital flows that could influence asset prices from New York to emerging markets. The BOJ has indicated it will proceed carefully, gauging each step against economic data. For a world used to Japan as a source of ultra-cheap money, this new phase introduces both opportunity (higher returns in Japanese assets) and risk (less global liquidity). As Japan transitions into 2026, the world will closely monitor its inflation gains and the extent of the BOJ’s intervention in this historic tightening cycle. The end of an era of zero rates in Japan may mark the beginning of a new equilibrium—one in which Japan’s monetary policy takes a more normal place among advanced economies, with profound implications for global finance.
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