The Bank of Japan (Bo J) raised its benchmark interest rate by 0.25 percentage points to 1.25% on Friday, the highest level in 31 years. The move marks the first hike since June and brings rates closer to what the central bank considers neutral for the economy, signaling a further departure from decades of ultra-low rates that made the yen a cheap global funding currency.

Japan is struggling with inflation driven by rising energy prices, global supply pressures, and domestic inflation exceeding the 2% target. Core consumer inflation held steady near the target in August as companies passed on higher costs for food and grocery items. A "slow-moving demographic shock" from a shrinking labor pool is lifting wages structurally, according to Bo J Executive Director Koji Nakamura.

The Federal Reserve's rate hike on Wednesday and potential further increases this year pressured the Bo J to keep pace. A widening U.S.-Japan rate gap risks weakening the yen and increasing inflation through higher import costs, analysts told Reuters. The Bo J's policy rate remains below the European Central Bank's 2.5%. Markets will closely watch Governor Kazuo Ueda's post-meeting briefing for clues on future rate hikes.