The BoJ will continue raising rates in Japan, but the pace is highly uncertain
The BoJ is edging toward another rate hike—but timing is everything. Inflation is rising, the yen is weakening, and global tensions could change the plan.
The Bank of Japan (BoJ) kept its policy rate at 0.75% at Tuesday’s meeting amid still-high uncertainty regarding the US/Israel war with Iran. We continue to project the central bank will resume rate normalization in July, but developments in the Middle East and the value of the yen could alter the timing.
The BoJ’s quarterly outlook raised the inflation outlook for fiscal years (FY) 2026 and 2027 and trimmed the growth forecast for 2026. The central bank projects underlying CPI inflation will increase gradually and reach the 2% inflation target in the second half of FY2026 and FY2027. The central bank’s projections appear slightly more optimistic than ours in terms of growth and more pessimistic in terms of inflation.
Governor Kazuo Ueda kept communication cautious by pointing out both upside and downside risks to prices. At the same time, he stressed the BoJ’s readiness to continue interest rate normalization arguing that underlying inflation is now approaching 2% and real interest rates are significantly low. The quarterly outlook also pointed out the risk of wage-inflation spiral for the first time.
We believe that the BoJ will wait until July to raise its policy rate to carefully assess how the terms-of-trade shock will deteriorate the cost-of-living crisis and small firms’ profits, which are also politically crucial for the Takaichi administration. We see the limited risk of a wage-inflation spiral because we think domestic demand will be stagnant and inflation expectations are stable.
Further yen weakening may provide the BoJ with a strong case for a rate hike in June to address the perception that the BoJ is getting behind the curve in fighting inflation. The terms-of-trade shock in 2022-2023 was significantly aggravated by yen weakening, which both the central bank and the government want to avoid. On the other hand, the BoJ may delay the next rate hike if the Middle East crisis continues.
