MNI POLICY: Hawkish Fed To Drive BOJ Caution

A more hawkish U.S. Federal Reserve, driven by the inflationary effects of President Donald Trump's tariffs, will drive caution among Bank of Japan policymakers and make near-term interest rate hikes less likely despite ongoing inflationary pressures, MNI understands.

The performance of the global economy and financial markets will hinge heavily on the direction of Fed policy and communications over the coming months and any risk of higher U.S. rates will increase concern over a slower economy, put downward pressure on stock markets and reduce expenditures.  

BOJ officials believe a worst-case scenario would see the Fed tighten rates to deal with higher inflation, which would destabilise the global economy and financial markets. However, they hope the Fed will prioritise supporting the economy in the short term rather than focusing on combating a supply-side driven inflation shock.

Powell on Friday warned Trump's tariffs could drive prices persistently higher, but said the Fed was not ready to hike interest rates, despite reaffirming the central bank’s commitment to fight inflation. "It is too soon to say what will be the appropriate path for monetary policy," he told reporters.

Governor Kazuo Ueda expressed a desire to stick to a gradual hiking strategy last month following the board's decision to hold the policy rate at 0.5%, but called for greater clarity on U.S. tariffs before the next decision on May 1. (See MNI BOJ WATCH: Ueda Sees Gradual Hikes, May 1 Possibility) While the Bank is set to continue its gradual approach to rate increases, officials will closely monitor the effects of U.S. tariffs on the domestic and global economies and their impact on Japan’s economy and inflation, before making any policy-rate adjustments.

STRONGER YEN

The stronger yen will also reduce upside price risk and give the BOJ time to access the impact of tariffs. 

However, the Bank will need to consider the yen’s strength and how it affects exporters’ profits, especially as slower global growth threatens the economy’s sustainable recovery and next year’s wage increases. Meanwhile, bank officials remain mindful of the risk that a weaker yen could fuel upward pressure on prices.

BOJ branch managers noted this week firms had voiced concern over the impact of the tariffs on their profits.