The Bank of Japan raised its benchmark interest rate by a quarter point to 0.5% Wednesday, the highest level in more than 10 years.
The BOJ said the economy was likely to continue growing and that it would make further rate adjustments slowly, although there were little signs of inflation.
The board voted eight-to-one in favour of a rate hike.
The Japanese yen rose against major currencies in anticipation of a rate rise, as the Japanese media reported that BOJ governor Toshihiko Fukui had proposed a rate increase. But once the official decision was made, traders locked in profits and the Japanese currency fell against the U.S. dollar and euro.
Market participants are happy the BOJ finally acted and raised rates, but the increase isn't the signal of a tightening cycle, Seijiro Takeshita, a senior strategist at Mizuho International, told "Squawk Box Europe"
"The economy isn't that strong, we know that we're on a mild trend of recover," Takeshita said.
At a press conference after the decision, Fukui said the BOJ plans "to adjust interest rate levels gradually" and that the central bank is "completely open" to the timing of another rate rise, according to Dow Jones.
Third Move in Less Than a Year
The market had been divided over whether the BOJ would move to head off the economic risks that arise from having ultra-cheap money rates for too long. The argument for raising rates was bolstered by data last week showing the economy growing faster than expected, although consumption and price pressures remain subdued.
The rise marks the third major policy move in less than a year. Last March, the BOJ ended its so-called quantitative easing policy of pumping excess money into the banking system. In July it followed up with a rate rise to 0.25% from virtually zero, the first rate increase in six years.
Japan's interest rates, despite Wednesday's move, are still well below benchmark rates in the United States, at 5.25%, or the euro zone, at 3.5%.
The wide gap in rates has encouraged investors to sell yen in recent months in favor of the dollar or euro.
Japan's economy is now in its longest post-war growth period, although it is expanding at a slower pace than in previous economic recoveries.
Data last week showed Japan's growth accelerated to an annualized 4.8% in October-December from 0.3% in the previous quarter, thanks to a rise in personal consumption. But there has been scant evidence of inflation after seven years of debilitating deflation.
The core consumer price index, which excludes volatile fresh food prices, in December was just 0.1% higher than a year earlier.
Such mixed economic signals in recent months have made many politicians nervous that the current expansion -- despite its longevity -- could peter out, just as so many other recoveries have since the early 1990s.