The Bank of Japan is weighing upside risks to prices from higher crude oil costs against downside risks to growth from a deterioration in the terms of trade, a dynamic likely to reinforce caution and keep the 0.75% policy rate unchanged at the March meeting, while potentially delaying further normalisation, MNI understands.
While the BOJ continues to signal that it will gradually raise the policy rate if its outlook for economic activity and prices materialises, with real interest rates still at significantly low levels, escalating tensions in the Middle East and volatile financial markets are driving caution among policymakers. Officials doubt current economic and price conditions warrant an immediate move, allowing the Bank time to scrutinise evolving geopolitical and market developments.
But rising crude oil prices are seen as worsening the terms of trade, squeezing income, dampening demand and ultimately exerting downward pressure on consumer prices. Simultaneously, higher energy costs combined with a weaker yen raise import prices, encouraging corporate pass-through and adding upward pressure to underlying CPI, complicating the BOJ's task.
While the the impact of rising crude oil prices is being contained, the BOJ’s policy decisions will depend on how high oil prices climb in the coming months.
Markets assign just a 5% probability to a rate move in March, while pricing in a 56% chance of a hike in May.
INFLATION EXPECTATIONS
Officials are concerned that medium- to long-term inflation expectations could overshoot the 2% target, given they are already not firmly anchored. Conversely, they are also alert to the risk that declines in headline CPI and gasoline prices could pull longer-term expectations lower.
There is no fixed scenario at this stage, reflecting uncertainty over the duration of geopolitical tensions and the extent of oil price increases.
In principle, central banks typically look through supply shocks. However, the BOJ is mindful of lessons from the U.S. Federal Reserve’s delayed 2022 response to what was initially assessed as temporary price pressures.
WAGE MOMENTUM
If concerns about the global economy intensify alongside financial market volatility, policymakers would be reluctant to raise rates. While they see a low probability of a sharp downturn, officials acknowledge that weaker global growth and softer headline CPI could undermine wage momentum.
Major firms are planning wage increases broadly in line with last year, basing decisions on elevated headline inflation in 2025 and persistent labour shortages.
Officials maintain that financial conditions remain accommodative. They are closely monitoring bank lending, funding demand and availability, as well as corporate bond and commercial paper issuance, while remaining vigilant to the risk that market volatility and global uncertainty could erode accommodative conditions.
