Nikkei Hit ATH 70,000 Amid Japan Rate Hike

Tokyo investors cheered as the Nikkei share index hit 70,000 points for the first time. The rally did not pause when the Bank of Japan raised its short-term policy rate to 1%, the highest in 31 years. Instead, the Nikkei surged by a third this year and Tokyo's stock market closed at a record high. Markets chose to hear reassurance: Bank of Japan governor Shinichi Uchida called the US-Iran memorandum to end the Middle East conflict "a welcome move" and said the risk of a sharp deterioration in the economy had diminished. Yet in the same appearance he added something harder to dismiss: there was uncertainty about how quickly oil supplies would rise.

That uncertainty now sits at the centre of Japan's economic policy. The Bank of Japan has lifted borrowing costs to their highest level since 1995, a shift described as a "step-change" in monetary policy. The move was widely expected, and investors expressed relief because it was not more hawkish; even a 50-basis-point increase had been discussed. But the Bank's confidence remains conditional. Uchida warned that price rises are broadening and that underlying inflation may deviate from the target. He stressed that underlying inflation is approaching 2% and that the target must be achieved stably. Stability, in other words, now depends on something the Bank does not control.

Markets celebrate while the source of stability remains uncertain

The contradiction begins in the Gulf. Although officials welcomed diplomacy, disruption of the oil market by the war in the Middle East has intensified. The future of global crude supply is becoming increasingly gloomy. The damage is partly linked to oil facilities around the Persian Gulf and mainly to the Iranian blockade of ships passing through the Strait of Hormuz. For Asia the chokepoint matters; for Japan it matters more. Many Asian countries depend on oil moving through the route from the Middle East, but Japan's dependence is greater than the others. The result is not theoretical. The economic consequences of the latest Middle East crisis can potentially be very serious.

Japan has already started paying the bill. The government's latest energy policy reflects a jump in fuel prices caused by the Iran conflict. In May, Japan tapped 510 billion yen to ease household energy bills. The Cabinet approved the package and allocated about 510 billion yen, or $3.2 billion, to help pay electricity and gas bills from July to September. Officials estimate the spending will cut utility costs for an average household by about 5,000 yen over three months. The money comes from a 1 trillion yen contingency fund, but contingency funds have a habit of becoming permanent when the shock they address refuses to fade.

That risk explains why the government returned only days later with something larger. On June 3, Prime Minister Sanae Takaichi's cabinet approved a 3.1 trillion yen supplementary budget to cushion households from rising energy costs amid the risk of a prolonged Middle East crisis. Most of the additional spending will replenish reserves already used to subsidise gasoline and utility bills. The package is not financed by growth or savings. It will be funded entirely through deficit-financing bonds, while the government seeks to avoid increasing overall bond issuance by relying on stronger tax revenues and non-tax income. The Cabinet also approved a plan requiring new debt financing, even as officials insist total bond issuance can remain unchanged because debt authorised in the 2025 fiscal year will be cancelled.

Japan returns to an old dilemma with little room for error

Japan has lived through oil shocks before. In 1973 the Bank of Japan raised rates as high as 9% to combat inflationary pressure from the Opec oil embargo. Decades later the problem reversed. By 2016 the Bank had adopted negative interest rates as it struggled against the deflationary slump that followed the end of the asset boom in the late 1980s. Today's Japan sits awkwardly between those histories: rates are rising because prices are rising, yet the government is borrowing to shield households from the same price increases that force the Bank to tighten.

The market celebration obscures that tension. Equities gained on expectations of gradual tightening and reduced Middle East risks, while an Iran-US peace deal boosted sentiment. But sentiment cannot reopen the Strait of Hormuz, lower fuel prices or remove the need for subsidies financed by debt. Japan's stock market has discovered that higher interest rates are survivable. What it has not yet confronted is that the country's new optimism rests on an oil supply outlook the Bank of Japan itself still describes as uncertain, even as the government borrows trillions of yen to protect households from the consequences.