The Bank of Japan is expected to raise its benchmark interest rate by 0.25 percentage points to 1.25% when its two-day policy meeting ends later today, September 18, AFP reports.

The move would take Japanese borrowing costs to their highest level in more than three decades, ending a long stretch of ultra-loose policy and responding to inflation stoked by a spike in oil prices linked to the Middle East crisis and by a yen that sank in July to its weakest against the dollar in 40 years. Several board members have already indicated they favour a hike. The previous increase came in June.

The Federal Reserve lifted its own benchmark to about 3.9% on September 16, while the European Central Bank raised rates the previous week.

"A hike to 1.25 percent at the September policy meeting has already been priced in," said Takehiko Nakao, Japan's former currency chief and former president of the Asian Development Bank. "In the face of advancing inflation, interest rates must be raised in a timely manner to contain it. If the response is delayed... you may end up having no choice but to raise rates sharply."

Inflation quickened in July towards the central bank's 2% target. "We expect inflation excluding fresh food and energy to rise further towards 2.5 percent by early next year," Marcel Thieliant of Capital Economics said, adding that "if the government doesn't resume subsidies for electricity and gas, higher generation costs could lift headline inflation well above three percent". He expects rates to reach 2% by mid-2027.

The yen's slide triggered a joint intervention by Tokyo and Washington in late July. That action "had a short-lived impact on the yen but has increased pressure on the BoJ to accelerate the pace of rate hikes", said Shigeto Nagai of Oxford Economics. "The economic and political cost of disappointing markets and the U.S. has become too big for the BOJ and government to ignore."

Japan's 10-year government bond yield rose above 3% on September 15, the highest since 1996, as investors weighed Prime Minister Sanae Takaichi's spending plans and a newly approved cut to the food sales tax from April.