The Bank of Japan is more confident about the economy

The widely-anticipated move was announced by the Bank of Japan at the end of a two-day meeting.

The move signals the Bank's confidence in the strength of the Japanese economy, which has seen accelerating growth and falling unemployment.

The rate increase also marks a significant shift in monetary policy, away from tackling deflation.

Economic revival

Economists said the move represented a watershed as consumer price rises, allied to strong economic performance, have pushed Japan out of the deflationary spiral of recent years.

The Bank of Japan was under significant pressure after ministers warned that any precipitous move on rates could stop the country's resurgent economy in its tracks.

Today's decision will contribute to achieving sustainable growth in the medium and to long term Bank of Japan Q&A: Why rates have gone up

In response, the Bank said it would keep rates "very low" for some time and would only increase them gradually.

"Today's decision will contribute to ensuring price stability and achieving sustainable growth in the medium and to long term," the Bank said after its unanimous decision.

The move comes against the backdrop of growing evidence that Japan's economy has turned the corner.

Output has grown in each of the past five quarters while unemployment has fallen to an eight-year low of 4%.

The government recently upgraded its annual growth forecast for the current year to more than 2%.

Falling shares

Interest rates have been rising across the industrialised world, with the US Federal Reserve and the European Central Bank both acting in recent months to contain inflationary pressures.

But Japanese ministers are nervous after what was seen as premature rate rise in 2000 led to an prolonged economic downturn.

Finance minister Sadakazu Tanigaki has said repeatedly he does not believe the time is right for a rise in rates.

Economists say indicators are much better than five years ago

Analysts welcomed the move, arguing that economic conditions were a lot more favourable than in 2000 when rates were last increased.

"The Bank of Japan is more than confident that this is the right time to do it," said Sikuho Takeshita, from Mizuho International.

"This time around what you are seeing is a sustained recovery through domestic growth."

But Japanese shares fell on Friday as oil prices hit a record $78 a barrel over fears of wider instability in the Middle East following intensified attacks by Israel on Lebanon.

The Nikkei-225 index closed down 252.71 points at 14,845.24.