The Bank of Japan is anticipated to refrain from raising interest rates at its two-day policy meeting that concludes on Tuesday, while adjusting its messaging to retain the option of further increases if inflation proves sustained due to the ongoing U.S.-Israeli war with Iran.
Market participants are paying particular attention to the central bank's quarterly outlook report and comments from Governor Kazuo Ueda for signals about how the protracted conflict could alter the BOJ's intended path toward higher, more neutral rates. Financial markets currently view a neutral policy rate for Japan as being around 1.5%.
Officials are widely expected to keep the short-term policy rate unchanged at 0.75% amid persistent market volatility tied to diminished prospects for a near-term end to the Iran war. Within the policy board, hawkish member Hajime Takata is likely to press for an increase to 1.0%, a proposal that market observers expect would be rejected by the board as it was in the preceding two meetings.
Nomura Securities executive rates strategist Mari Iwashita summed up the prevailing view, saying: "Even if it were to keep rates steady this time, the BOJ is probably unwavering in its resolve to continue with further rate hikes. Governor Ueda will need to stress the BOJ's readiness to continue raising rates to avoid further declines in the yen." Her comments reflect concern that an unambiguous signal of continued tightening will be needed to support the currency.
Japan's heavy dependence on imported oil renders the economy particularly exposed to spikes in energy prices and to supply disruptions stemming from the effective closure of the Strait of Hormuz. Those developments have complicated the BOJ's effort to lift still-low interest rates gradually toward levels many judges neutral for the economy.
While policymakers earlier appeared inclined to look through short-lived, war-driven swings in commodity prices, the incidence of firms passing higher input costs through to consumers has risen. A persistently weak yen adds to upward pressure on costs, keeping inflation above the BOJ's 2% target for four years and prompting consideration of a quicker response.
The measured pace of previous BOJ rate increases has weighed on the yen, which remains close to the 160-per-dollar threshold that in the past triggered currency intervention to support the currency. Against that backdrop, the central bank is expected to stress its determination to press on with additional rate increases where necessary, given the risk that an energy shock could translate into broader, sustained inflation, sources said.
To communicate that flexibility, the BOJ may alter the wording of its policy guidance. The existing pledge to raise rates "in accordance with economic and price improvements" could be adjusted to better signal willingness to act in response to inflationary pressures stemming from the conflict.
Investor expectations already point to further tightening. Nearly two-thirds of economists surveyed expect the BOJ's benchmark rate to reach 1.0% by the end of June.
With higher fuel costs expected to erode corporate profit margins, the central bank is preparing to lower its growth forecast for the fiscal year that began in April in the quarterly outlook. At the same time, the board is likely to sharply revise upward its inflation forecast for fiscal 2026, reflecting rising oil-related input costs that are prompting some firms to weigh price increases.
In its January projections, the BOJ had anticipated real economic growth of 1.0% in fiscal 2026 before a slowdown to 0.8% in 2027. Those same forecasts projected core inflation at 1.9% in fiscal 2026 and 2.0% in 2027. For the first time, the upcoming quarterly report will include forecasts for fiscal 2028.
As markets parse the BOJ's latest projections and Governor Ueda's commentary, attention will center on how the central bank balances the near-term decision to hold rates against the prospect of additional tightening if the Iran conflict continues to push up global energy prices and domestic inflation readings.
What to watch:
- Language in the quarterly outlook and Governor Ueda's press comments for indications of policy flexibility.
- Whether Hajime Takata formally proposes a move to 1.0% and how the board responds.
- Revised growth and inflation forecasts, including the newly added fiscal 2028 projections.