MNI POLICY: BOJ Sees Economic Risks Clouding Rate Hike Outlook

The timing of future rate hikes is expected to become even more uncertain as the Bank of Japan board highlights increasing downside risks to the economy and greater price volatility driven by U.S. tariffs following its next policy decision on May 1, a shift from January's more balanced view, MNI understands. 

The adjustment comes as officials struggle to establish a baseline scenario for the economy and prices amid market volatility triggered by the implementation, and subsequent partial rollback, of President Donald Trump’s tariffs.

While the BOJ expects the duties to drive Japanese and global growth lower, they find gauging the extent of the downturn difficult, particularly as they await harder economic data. The Bank will examine and potentially adjust its baseline scenario following each economic data print before publishing its updated view in July. 

However, declines in confidence and sentiment indicators suggest weaker consumer spending ahead.

Hawkish comments from the Federal Reserve have made near-term BOJ rate hikes less likely, according to MNI this week. (See MNI POLICY: Hawkish Fed To Drive BOJ Caution) This shift is reflected in market pricing, which has reduced the year-end policy rate forecast by about 15 basis points to 0.6%. 

MARKET INFLUENCE

Officials see both upward and downward pressure on inflation, driven in part by fluctuations in the U.S. dollar–yen exchange rate, while the impact of tariffs on wider currency markets has made it harder to assess inflation trends.

A stronger yen will lower upside price risk, but it will squeeze exporters’ profits and undermine the foundation for a sustainable economic recovery and wage hikes. However, a weak yen will increase the inflationary pressure through higher import prices and add pressure on the BOJ to raise the 0.5% policy rate.

Bank officials are also concerned volatile stock markets will prevent firms from investing and households from spending, which will increase downward pressure on the economy. But they doubt a weaker economy will drive underlying inflation lower as firms continue to raise wages to deal with the labour shortage and pass those costs on.

Real wages remained negative in February for the second consecutive month, eroding households’ purchasing power. 

Bank officials expect real wages to turn positive sometime in or after mid-2025. The BOJ will also closely monitor whether businesses follow through with planned retail price hikes during the usual seasonal adjustments in April.