Fresh turbulence in global markets linked to the conflict in the Middle East has heightened the chance the Bank of Japan will hold off on raising interest rates at its March 18-19 policy meeting, according to multiple people close to the BOJ's internal discussions. Those people said policymakers want additional time to assess how the geopolitical shock and prior rate increases are filtering through the economy.
Sources said that a rapid and pronounced slump in the yen remains the single tangible trigger that could prompt the BOJ to tighten policy in March. The yen has weakened after U.S. strikes on Iran and moved closer to the psychologically significant 160 level amid strong demand for the safe-haven dollar.
At the same time, these same people said the bar for a March rate rise has risen because the widening Middle East conflict has unsettled financial markets and driven up oil prices. That combination, they warned, clouds the outlook for an economy heavily dependent on imported energy.
"It’s become difficult for the BOJ to raise rates," one of three sources familiar with the central bank’s thinking said, echoing the broader view expressed by interlocutors who spoke on condition of anonymity because they were not authorised to comment publicly.
Two other sources highlighted the need for the BOJ to study how its earlier rate hikes, together with the shock from the Middle East, will influence growth and prices. They said the overall impact will hinge critically on how long the conflict persists.
One source cautioned that although higher oil prices could feed through to underlying inflation, persistent geopolitical tensions could also undermine economic activity and therefore justify postponing further tightening.
Market and official signals
Financial markets pared back expectations of a March increase after BOJ Deputy Governor Ryozo Himino declined on Monday to offer clear hints of an imminent policy shift. That restraint contrasted with comments from Governor Kazuo Ueda, who in a February 26 interview with the Yomiuri newspaper left open the possibility of a hike in March or April but stressed any decision would depend on the data available when the meeting occurs.
Analysts note the absence of hawkish pre-announcements from BOJ officials stands in contrast to earlier phases of monetary tightening, when officials tended to telegraph possible moves to avoid surprising markets.
"Himino would have given some hints if the BOJ had been contemplating a March hike. The fact he didn’t convinced me it will forgo a hike this month," said Katsutoshi Inadome, senior strategist at Sumitomo Mitsui Trust Asset Management. "I see April as the most likely timing of the next rate hike, particularly if the yen continues to weaken," he added.
Market-implied odds of a March rate increase dropped to about 5% from roughly 10% after Himino’s remarks, while market participants put the chance of an April 27-28 hike at about 60%.
Despite the near-term uncertainty, a majority of economists surveyed by Reuters still expect the BOJ to raise its policy rate to 1.0% by the end of June.
Policy context and political considerations
The BOJ raised its policy rate to 0.75% in December, a 30-year high, taking another step away from the era of exceptionally loose monetary policy and signalling its judgment that Japan is moving toward sustainably achieving its 2% inflation target. The central bank has indicated it stands ready to raise rates further if its economic and inflation forecasts are realised.
While Deputy Governor Himino declined to specify timing, he said the BOJ is expected to continue increasing rates toward levels viewed as neutral for the economy. Himino’s comments followed those of board member Hajime Takata, who urged vigilance against the risk of an inflation overshoot.
Analysts note that another sharp depreciation of the yen could provide the BOJ with justification for a near-term rate rise, as occurred in December.
Political developments have also increased the likelihood the BOJ will pause. Prime Minister Sanae Takaichi has emphasised a political priority of reviving the economy following her party’s decisive victory in the February general election. Last week she nominated two monetary doves to the BOJ board, a move interpreted by market participants as signalling reluctance toward more rapid rate increases. Those nominations followed reports that she expressed reservations about additional rate hikes during a meeting with Governor Ueda last month.
"Given no clear signals from Himino, the BOJ probably doesn’t have a March rate hike in mind," said Mari Iwashita, executive rates strategist at Nomura Securities. "While the BOJ’s policy to keep raising rates likely remains unchanged, the fresh uncertainty caused by the Iran conflict makes its decision on the next rate-hike timing difficult."
Outlook
Policymakers face a trade-off. Higher oil prices resulting from the Middle East conflict could lift underlying inflation readings, increasing pressure to tighten policy. At the same time, if the geopolitical shock proves persistent and depresses demand, it could argue for a pause in the tightening cycle. With official comments muted and market-implied odds reduced for March, April has emerged in market pricing as the more plausible window for the next move, contingent on developments in currency markets, energy prices, and incoming data.