The Bank of Japan (BoJ) has raised interest rates to a 31-year high, as it tried to dampen inflationary pressures created by the Iran war.

Policymakers in Tokyo raised the BoJ’s short-term policy rate by a quarter of one percentage point, to 1% from 0.75%, and warned that companies were passing on rising oil costs to each other at a “relatively fast pace”.

The BoJ decided to tighten monetary policy despite the fall in the oil price in the past few days, as Washington and Tehran agreed the basic structure of a peace deal, and also despite Japan’s annual core inflation having fallen to a four-year low of 1.4% ​in April.

The central bank’s governor, Shinichi Uchida, told a press conference in Tokyo that the signing of a memorandum by the US and Iran to end the Middle East conflict was “a welcome move”. He also warned there was “uncertainty” about how quickly oil supplies will rise.

“Compared with the previous meeting, the risk of a sharp deterioration in the economy has diminished. On the other hand, price rises are broadening, and there is a risk that underlying inflation may deviate from our target,” Uchida said.

“With underlying inflation approaching 2%, it’s important to ensure we achieve our target stably.”

The BoJ also said the risk of Japan’s economy deteriorating sharply from the Middle East conflict had diminished. It cited the government’s relief package to help households facing high fuel costs.

Tuesday’s rate rise has lifted Japan’s borrowing costs to their highest since 1995, when the BoJ was midway through lowering interest rates after the bubble in property and asset prices burst.

“The move – increasing the short-term policy rate to 1% from 0.75% – was widely expected, but it’s a step-change in monetary policy for Japan, given it pushes borrowing costs to levels not seen since 1995,” said Susannah Streeter, the chief investment strategist at Wealth Club.

“There was some relief that the move wasn’t more hawkish, with even a 50-basis-point hike having been mooted.”

In 1973, the BoJ raised rates as high as 9% as it tried to combat the inflationary pressures from the Opec oil embargo. But by 2016, the BoJ was implementing a negative interest rate policy, as it tried to drag Japan out of the long deflationary slump that followed the end of its asset boom in the late 1980s.

Tokyo’s stock market closed at a new record high, after the Nikkei share index hit 70,000 points for the first time during Tuesday’s session. The Nikkei has soared by a third so far this year.

The BoJ is the second G7 bank to raise borrowing costs since the Iran war began. Last week the European Central Bank lifted its main interest rates. The US Federal Reserve and the Bank of England are expected to leave borrowing costs unchanged at their monetary policy meetings this week.