Tokyo, March 2 - Global market turbulence linked to strikes on Iran and Tehran's retaliation has upended expectations around Japanese bond yields and the timing of the Bank of Japan's next rate increase. Investors are split between safe-haven flows that could support bond demand and inflation risks that could push policy makers toward further tightening.
On Monday, the two-year Japanese government bond yield - the maturity most sensitive to BOJ policy rates - fell 3 basis points to 1.215% as markets absorbed the impact of joint strikes by the U.S. and Israel on Iran. The attacks and subsequent missile barrages from Tehran followed the killing of Supreme Leader Ali Khamenei over the weekend, and U.S. President Donald Trump signalled the assault on Iran could continue for weeks.
Market reaction and the policy window
The immediate move lower in short-dated JGB yields reflected a pullback in expectations for an imminent BOJ rate rise. That reaction contrasts with a longer-running market narrative that persistent weakness in the yen and rising import costs could accelerate inflation and prompt earlier tightening by the central bank.
Analysts highlight a direct trade-off: a prolonged conflict could lift energy prices and weaken the yen, both of which would raise the prospect of imported inflation - a factor that could push the BOJ to act more quickly. "The BOJ may have to hurry in raising rates if the conflict continues because rising oil prices would accelerate inflation and the yen may fall," said Hiroshi Namioka, chief strategist at T&D Asset Management. "The BOJ is already behind in raising rates."
The BOJ itself has been on a path of policy normalisation, having raised its key rate in December and signalling further increases were likely. Market expectations for the timing of the next move had already shifted earlier in recent weeks, with pricing moving to as soon as April from previously pencilled-in dates in June or July.
Central bank comments and cross-currents
BOJ Deputy Governor Ryozo Himino said on Monday that market volatility would not in itself prevent a rate increase, but he offered no guidance on timing. Himino stressed that the decision would depend on the inflation rate stabilising around the central bank's 2% target.
That conditional stance leaves markets balancing two opposing forces. Mizuho Securities chief bond strategist Noriatsu Tanji noted that haven flows into safe assets may support bond prices, while inflation fears could encourage selling as investors price in future rate hikes. "We believe that the BOJ and other central banks are likely to focus more on rising inflation than deteriorating economic performance - and turn commensurately more hawkish - even if things do start to turn stagflationary," Tanji wrote in a note.
Political backdrop and economic priorities
Political developments in Tokyo also complicate the outlook. Prime Minister Sanae Takaichi came to power promising expanded fiscal stimulus and is thought to view BOJ tightening skeptically because of its potential to slow the economy. That political stance adds another element to the policy debate, as government preferences on stimulus and central bank actions can influence markets' assessment of monetary policy timing and magnitude.
Some market participants argue that an extended Iran crisis would inflict broader damage on Japan's economy beyond a simple uptick in inflation. That line of thinking bolsters the argument for a more cautious BOJ, focused on supporting growth if core inflation readings are judged to remain below target.
"Since the BOJ views underlying inflation as below 2%, it would prioritize supporting the economy," said Naoya Hasegawa, chief bond strategist at Okasan Securities. "So in that sense, a rate hike in April, seen as a likely scenario among many market players, may be delayed."
Outlook
With conflicting signals from markets, geopolitics and domestic politics, the path and timing of Japan's next rate increase remain uncertain. Short-term JGB price action has reflected a flight to safety, but strategists caution that sustained pressure on oil prices and a weaker yen could shift central bank priorities back toward containing inflation.
For investors and policy watchers, the unfolding situation in the Middle East will be a key variable shaping expectations for Japanese yields and the BOJ's policy trajectory in the coming weeks.