The bank of Japan raised the discount rate from 5.25 percent to 6.25 percent to check inflation and to support a weakening Japanese yen.
The step to increase the charge on lending to commercial banks was long overdue, reliable American banking sources said.
This was the third discount rate increase of the year. It was raised in July from 4.25 percent to 5.25 percent after a 0.75 percent increase in April.
The announcement was made after an extraordinary policy board meeting of the bank after the stock and foreign exchange markets had closed.
The step was taken because of the continuing depreciation of the Japanese yen, which had contributed to Japanese inflation because of higher import costs.
The Tokyo foreign exchange market closed today with the yen quoted at 238.05 to one U.S. dollar, up slightly from 237.70 yen Wednesday.
The Bank of Japan's prime reason for raising the discount rate was the soaring inflation, which is rising by 4 percent annually, and surging wholesale prices, which are rising at double-digit rates.
Another reason for the action by the Bank of Japan was the growing interest-rate gap between Japan and other Western countries. The U.S. discount rate is up to 12 percent, and West Germany just raised its rate to 6 percent.
The Bank of Japan believes that credit tightening is necessary to maintain some control of inflation, fueled by rapidly rising oil prices.
The new discount rate will be followed by increases in deposit and savings interest rates.