TOKYO, March 12 - The recent conflict in the Middle East has produced fresh supply shocks that, according to four people familiar with the Bank of Japan’s thinking, could accelerate the central bank’s move toward tighter policy by raising inflationary pressures. Those sources say a further rate increase as soon as April cannot be ruled out, even as the same shocks create a meaningful risk of weakening global demand and hitting Japan’s fragile recovery.
The conflict, which has unfolded over the past fortnight, has injected volatility into global markets and left policymakers weighing whether to respond with tighter or more accommodative settings. In Japan, the BOJ’s shifting emphasis toward the upside risks to prices represents a departure from its longstanding priority of using low borrowing costs to cushion growth - a change driven by evolving inflation dynamics.
Inflation risk versus growth risk
The sources interviewed on condition of anonymity said the Middle East tensions are more likely to push up crude oil prices first, increasing inflation before any growth squeeze materializes. That initial burst of fuel-driven inflation has the potential to influence public perceptions of prices, which the BOJ has been closely monitoring.
"The conflict comes at a time underlying inflation is already close to 2%," one of the sources said, a concern echoed by three other sources. That proximity to the BOJ’s target means policymakers are more vigilant about upside price risks than they might have been in the past.
At the same time, those same sources cautioned that the conflict could precipitate a broader global downturn that would damage Japan’s recovery and force the BOJ to revise optimistic economic projections and any plans for further rate hikes.
How markets are pricing the risk
Market bets on the timing of the next BOJ move have not collapsed in the wake of the conflict. An April rate increase remained priced in at roughly 60% by investors, suggesting that market participants, like the BOJ, are increasingly focused on the upside risks to inflation stemming from the supply shock.
Why this episode may change BOJ behavior
Historically, the BOJ tended to look through temporary cost shocks - such as rising oil prices - and concentrate on supporting a weak economy where both households and firms had become accustomed to low inflation and sluggish wage growth. That approach shaped a gradual and cautious withdrawal from massive monetary accommodation in past years.
Following Russia’s invasion of Ukraine, for example, it took the BOJ two years to begin unwinding a decade-long stimulus, finally starting to exit in March 2024 even though rising raw material costs had pushed inflation above the 2% target. Since then, the bank has raised rates to 0.75%.
But sources say the BOJ may not be able to afford the same level of patience this time. The fuel price spike from the Middle East crisis compounds the effects of a persistently weak yen and rising import costs that have already led many firms to raise prices. Inflation has remained above the BOJ’s target level for nearly four years, and that persistent pressure is influencing central bank thinking.
Shifts in expectations and wage trends
Inflation expectations have been moving higher. In recent BOJ surveys, firms forecast inflation averaging 2.4% five years out, while households projected 9.8% for the same horizon. At the same time, Japan’s chronic labour shortage has pushed firms to increase wages, including last year’s agreement for the largest pay rise in 34 years.
Those developments have produced calls within the BOJ board for steady rate increases to avoid falling behind in containing the risk of persistently high inflation. On February 26, hawkish board member Hajime Takata said, "Medium- and long-term inflation expectations are heightening, and price increases now have a greater tendency to generate second-round effects," and urged steady rate hikes.
Public statements from the BOJ and outside economists
Governor Kazuo Ueda, speaking days after the U.S. attack against Iran on February 28, cautioned that the conflict could worsen Japan’s terms of trade and thus hurt the economy, but he also warned it could lift underlying inflation. The BOJ has underscored its renewed focus on inflation in other ways as well: on February 4 it published an academic paper arguing that intensifying supply constraints can have a "persistent impact" on prices, both through actual cost increases and by lifting inflation expectations.
Ahead of the BOJ’s upcoming policy meeting, the central bank is widely expected to keep rates unchanged at that session. Sources say Governor Ueda is likely to reiterate the bank’s commitment to continue normalizing policy and to leave the option open for near-term action during the post-meeting briefing.
Ayako Fujita, chief Japan economist at JPMorgan, said she expects the BOJ’s message to emphasize remaining on the "normalization path" while also "assess[ing] uncertainties related to the Iran war." Fujita added that such wording would stop short of committing to an April move while preserving the option if conditions stabilise.
Voices stressing urgency
Some former BOJ officials argue the conflict-driven volatility will probably delay near-term tightening until mid-year, but that the central bank must continue to monitor mounting price pressure closely. Seisaku Kameda, the BOJ’s former top economist, said the bank is already behind the curve in responding to rising inflationary pressures and warned that the risk of being late could grow further amid higher oil prices and a weak yen.
Policy trade-offs and political pushback
Policy deliberations are not happening in a vacuum. The same supply shock that raises inflation risks could also provide the government with grounds to resist early rate increases. The article’s sources say the dovish premier, Sanae Takaichi, is known to have reservations about further hikes in borrowing costs, and the war could give policymakers another reason to press back against quicker tightening.
In short, the BOJ faces a classic policy dilemma: act now to prevent higher inflation from becoming entrenched, or hold off to shield a fragile recovery from potential demand shocks. The Middle East conflict has made that choice more acute by increasing the odds of a near-term spike in inflation while simultaneously elevating the possibility of a global slowdown that would dampen Japan’s growth prospects.
What to watch next
- The BOJ’s immediate messaging at the post-meeting briefing, which is likely to reaffirm the normalization path while leaving options open for near-term moves.
- Oil price trajectories and their short-run impact on consumer prices and public price perceptions in Japan.
- Market pricing for an April move - which currently sits around 60% - and whether that shifts as conflict developments and economic data unfold.
The balance between containing inflation and protecting growth will determine whether the BOJ tightens policy sooner than previously expected or waits as downside risks to the economy rise. For now, the supply shock from the Middle East has pushed inflation risks higher, making the central bank’s decision calculus more complex and politically charged.