The move puts Japan in step with the world's other major economies.
In June, Europe's central bank raised its key interest rate to 2.75%, while in the US, the Federal Reserve has lifted the fed funds rate 17 times in a row to now stand at 5.25%.
Toshihiko Fukui, governor of the Bank of Japan, emphasized that the bank is acting cautiously and that the economy is now on a much better footing.
Fukui said: "We are not embarking on so-called consecutive interest rate hikes, we will carefully study the state of the economy and prices to gradually adjust interest rates."
The Japanese economy has strengthened in recent months, experiencing increasing growth and falling unemployment.
Most importantly, deflation has largely been defeated with consumer prices recovering.
Junichiro Koizumi, Japan's prime minister, said: "I think the Bank of Japan took the country's continued economic growth into consideration.
"I hope we emerge from deflation as soon as possible... I think we are getting close, though we are not yet there."