The Bank of Japan is facing a critical moment in its monetary policy trajectory, as its cautious rate-hike cycle confronts new headwinds driven by escalating global trade tensions and persistent inflationary pressures. Governor Kazuo Ueda, who has led the central bank for two years, opted to keep interest rates steady at 0.5% following the latest policy meeting, noting that the timeline for inflation to sustainably reach the BOJ’s 2% target has been “pushed back somewhat.” This indicates a likely pause in further hikes to allow for clearer insights into the economic effects of recently imposed U.S. tariffs.
Despite the pause, the Bank of Japan is unlikely to completely abandon its tightening bias. Factors such as steady food inflation, expectations of continued wage growth, and concerns over a weakening yen provide grounds for the central bank to maintain a hawkish tilt. Analysts expect the BOJ to keep markets on edge by signaling a potential hike while refraining from committing to a specific timeline.
Former BOJ economist Akira Otani, now at Goldman Sachs Japan, suggests delaying hikes further to avoid stalling the inflation target amid ongoing uncertainty. Goldman forecasts the policy rate could eventually rise to 1.5%, but Otani now estimates the next increase may not come until January. Similarly, Morgan Stanley, which previously projected a hike in September, now expects rates to remain at 0.5% through next year unless inflationary pressures intensify or the yen depreciates significantly.
The BOJ’s revised projections show tepid economic growth, a downgrade in inflation expectations, and heightened downside risks, reflecting the institution’s cautious stance. Still, Ueda reaffirmed his commitment to normalization, stating inflation would likely re-accelerate, buoyed by wage growth and a tightening labor market.
Japan’s inflation landscape is shifting, with core inflation exceeding the BOJ’s 2% target for three consecutive years. Food prices, particularly for staples like rice, have surged, pushing March’s headline inflation to 3.6%. The BOJ acknowledged for the first time the risk of food inflation leading to broader, more persistent price increases. Ueda admitted that the stickiness of food price inflation caught policymakers by surprise.
Any further dovish tone could weaken the yen, intensifying inflation and triggering political pressure from the U.S., where criticism of Japan’s currency policy is mounting. The yen dropped to 144.74 per dollar after the BOJ’s outlook, its weakest since early April, signaling growing market skepticism over near-term rate hikes.
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