Japan’s Central Bank Faces Complex Challenges in Interest Rate Decisions
The Bank of Japan (BOJ) is anticipated to maintain its current interest rate on Tuesday, but it may signal a shift from its previously hawkish stance. This move could allow the central bank to increase borrowing costs in the coming months to address inflationary pressures exacerbated by the ongoing conflict in the Middle East.
The U.S.-Israeli war with Iran has introduced significant complexity into the BOJ’s efforts to gradually raise interest rates to levels considered neutral for the economy, which are estimated at around 1.5%. Market participants are closely monitoring the BOJ’s quarterly outlook report and statements from Governor Kazuo Ueda for insights into how the prolonged conflict in Iran might influence the central bank’s rate-hike trajectory.
During a two-day meeting concluding on Tuesday, the central bank is expected to keep its short-term policy rate unchanged at 0.75%, as the diminishing likelihood of an imminent end to the Iran war continues to create market volatility.
Hajime Takata, a hawkish member of the board, may advocate for raising the policy rate to 1.0%, although this proposal is likely to be rejected by the board, similar to previous meetings.
Mari Iwashita, executive rates strategist at Nomura Securities, noted that “even if the BOJ keeps rates steady this time, it is probably unwavering in its resolve to continue with further rate hikes.”
“Governor Ueda will need to stress the BOJ’s readiness to continue raising rates to avoid further declines in the yen,” she added.
Economy Minister Minoru Kiuchi, known for his advocacy of loose monetary policy, stated he will attend Tuesday’s BOJ meeting as a representative of the Cabinet Office.
“We hope the BOJ guides monetary policy appropriately to sustainably and stably achieve its inflation target while closely communicating and coordinating with the government,” Kiuchi said during a news conference when asked about the BOJ’s intention to continue raising interest rates.
Two government representatives, one from the Ministry of Finance and another from the Cabinet Office, can attend the BOJ’s policy meetings. They cannot vote but can voice opinions and request a delay in the board’s vote on policy decisions.
The BOJ will be the first among a group of central banks expected to keep policy steady this week, including the U.S. Federal Reserve, as the Middle East war complicates the economic outlook.
Potential Adjustments to Policy Guidance
Japan’s heavy reliance on oil imports makes its economy susceptible to the impact of rising oil prices and supply disruptions caused by the effective closure of the Strait of Hormuz.
However, the risks of overlooking the price pressure driven by the war have increased as companies become more inclined to pass on higher costs, including those from a persistently weak yen, keeping inflation above the BOJ’s 2% target for four years.
The slow pace of BOJ rate hikes has affected the yen, keeping it near the 160-per-dollar level, which previously prompted currency intervention to support the struggling currency.
Unlike last year, when higher U.S. tariffs forced a pause in its rate-hike cycle, the BOJ is expected to emphasize its commitment to continuing rate increases as the energy shock poses a risk of fueling widespread inflation, according to sources.
The central bank may adjust its policy guidance, which pledges to raise rates “in accordance with economic and price improvements,” to better convey its flexibility in addressing inflation risks from the war, they said.
Nearly two-thirds of economists surveyed expect the BOJ to raise its benchmark rate to 1.0% by the end of June.
With rising fuel costs projected to affect corporate profits, the BOJ is set to lower its growth forecast for the fiscal year starting in April in its quarterly report, according to sources.
The board is also expected to significantly revise upward its fiscal 2026 inflation forecast, as increasing costs for oil-related raw materials are prompting some firms to consider price hikes.
In current forecasts made in January, the BOJ expects the economy to grow 1.0% in fiscal 2026 before slowing to 0.8% in 2027. It projects core inflation to reach 1.9% in fiscal 2026 and 2.0% in 2027. Next week’s quarterly report will include forecasts for fiscal 2028 for the first time.
