For most economists, it is widely expected that the Bank of Japan will maintain its current monetary policy unchanged this week. However, this meeting holds significant strategic importance as authorities weigh whether preemptive measures are needed against soaring oil prices to prevent the risk of inflation overheating. According to informed sources, Japanese prices have exceeded the central bank's 2% inflation target for four consecutive years. This persistent overshoot reinforces the bank's assessment that "genuine inflation expectations are finally beginning to take root." Currently, rising energy prices are further increasing corporate input costs. If more companies choose to pass these costs on to consumers, the Bank of Japan will face a dual policy choice: supporting the economy against supply shocks versus restraining excessively rapid price increases.
This decision will further demonstrate that, after years of acting as an "experimental special case," the Bank of Japan is gradually returning to a policy normalization track and beginning to confront the core dilemma commonly faced by traditional central banks: how to balance economic growth with price stability. Notably, this is the first time since the asset bubble burst in the 1990s—which led to prolonged economic stagnation and deflation—that Japanese policymakers have encountered such a predicament. For decades prior, they could prioritize measures to support economic growth without excessive concern about the risk of prices spiraling out of control.
When faced with rising input costs driven by inflation in raw material markets, companies have typically chosen to maintain stable product prices, absorbing the cost shocks themselves to preserve market share. To protect profit margins, corporate executives have often strictly controlled wage expenditures and investment scale. Consequently, workers and consumers gradually developed expectations that costs and incomes would face downward pressure. During that period, supply-side shocks often prompted the Bank of Japan to implement increasingly experimental monetary easing measures to cushion the economic impact, including negative interest rates and large-scale asset purchases.
Since assuming office in April 2023, Bank of Japan Governor Kazuo Ueda has steadily advanced the gradual exit from experimental monetary policy tools. He has consistently emphasized that, although Japan has experienced a prolonged inflation process, the underlying inflation trend has still not reached the 2% target level. However, the recent sustained surge in oil prices could rapidly alter this assessment. The transmission of energy costs will accelerate the formation of inflation expectations, potentially bringing actual inflation dynamics closer to the policy target sooner than anticipated.
In this context, continued interest rate hikes are seen as a crucial means to maintain stable price growth. But policymakers must be wary of a dual risk. On one hand, rising borrowing costs could combine with a potential global economic slowdown triggered by conflicts such as the U.S.-Iran tensions, exerting downward pressure on Japan's export-oriented economy. On the other hand, if monetary policy is tightened too early, worsening the output gap, it could undermine demand-driven price increases and cause the inflation trend itself to falter.
This contradictory dynamic complicates policy discussions. Some officials view recent inflation as more of a temporary phenomenon, while others point out that households feeling the pinch of rising living costs do not share this view of "superficial inflation." According to sources, some dissenting board members had called for consecutive rate hikes at the January meeting. However, the prevailing wait-and-see attitude among officials recently suggests that policymakers are in no rush to push for more members to blindly follow a rate hike at this month's meeting.
Sources further indicate that policymakers are closely monitoring developments in geopolitical conflicts and assessing a range of economic scenarios. Given the highly uncertain and rapidly changing situation, they may even reach a consensus by the conclusion of the monetary policy meeting on March 18-19 that it is still premature to conclude that uncertainty for Japan's economy has significantly intensified. Market expectations for a rate hike this month are currently around 6%, while the probability is forecast to rise to approximately 63% by the April meeting. A survey of Bank of Japan watchers showed that April is seen as the most likely timing for a hike, with over one-third of respondents predicting an increase then.
For policymakers, the core question is to determine whether Japan has truly escaped the grip of deflation. If deflation has been overcome, the Bank of Japan may need to accelerate the pace of interest rate hikes to anchor inflation expectations and maintain price stability. If not fully free from the shadow of deflation, a more cautious policy stance is required to avoid prematurely tightening monetary policy and impacting the economic recovery.
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