Seiji Adachi, who served on the Bank of Japan board until March of last year, told Reuters that elevated oil prices resulting from the Middle East conflict raise the likelihood that the BOJ will lift interest rates by July. Adachi said the risk that the central bank could lag in its response to mounting inflation has increased because of those energy-cost pressures.
Adachi pointed to recent survey data indicating that underlying inflation has already reached the BOJ's 2% target. He highlighted results from last week's tankan corporate survey, which showed five-year inflation expectations among companies at 2.5%, as evidence that inflationary dynamics are firming.
At present, the BOJ's short-term policy rate stands at 0.75%. Adachi argued that, given current conditions, it would be preferable for the central bank to move rates toward a level he considers neutral to the economy as soon as feasible. He estimated Japan's neutral policy rate to be roughly 1.25%.
While Adachi said a rate increase is likely before July, he described the prospect of a hike in April as a 50-50 call. He noted that the Iran war has injected volatility into markets and clouded the outlook for Japan's fragile economy, complicating the decision to act immediately. "The BOJ will probably raise rates again in April, June or July," he said, referencing the central bank's recent hawkish tone and the release of data that could justify further tightening. He added that determining whether to move in April would be difficult because the economic consequences of the conflict remain unclear.
Adachi also pointed to political considerations that could influence the BOJ's near-term strategy. He said the appointment of two officials described as reflationists to the BOJ board by a dovish Prime Minister, Sanae Takaichi, suggests the administration is not in favor of additional rate increases in the immediate term. "Rate hikes would push up the cost of corporate borrowing. That runs counter to the administration's push to boost investment in growth areas," he said.
Markets have been unsettled since the Iran war effectively closed the Strait of Hormuz, a chokepoint for about a fifth of global oil and gas flows. That development has driven crude prices higher and strengthened the safe-haven dollar against the yen, complicating the BOJ's path to higher rates. Despite that complication, markets have responded to the BOJ's hawkish messaging and rising inflationary pressures by pricing in roughly a 70% probability of an April rate hike.
Adachi said he expects the BOJ to pursue two rate increases this year, which would move the policy rate toward the level he identifies as neutral. He warned, however, that if the Middle East conflict becomes protracted and triggers an oil shock lasting more than a year, the central bank may need to accelerate the pace of increases. In that scenario, the BOJ would need to raise rates faster to push real borrowing costs out of negative territory.
Adachi concluded by acknowledging that Japan is not yet facing such a prolonged shock but warned of the difficult choices ahead if the conflict continues. "We're not there yet," he said. "But depending on how the conflict unfolds, the BOJ will face a very tough decision, sandwiched between rising inflation and low growth."
Summary of implications
- Rising oil prices tied to the Middle East conflict increase inflationary pressure and the risk the BOJ will fall behind the curve.
- Corporate five-year inflation expectations at 2.5% and underlying inflation reaching 2% add weight to arguments for rate normalization.
- Political appointments and uncertainty over the economic fallout from the Iran war complicate the timing of any BOJ hikes.