The Bank of Japan is leaning toward keeping its policy rate unchanged next week due to uncertainties stemming from the conflict involving Iran, though officials remain committed to raising borrowing costs at some point. Given the highly volatile situation in the Middle East and the potential for significant shifts in the economic outlook, policymakers see no urgency to lift the benchmark interest rate immediately.
Even if the final decision on April 28 is to maintain the overnight rate at 0.75%, the central bank is expected to retain its stance that further rate hikes will proceed when conditions allow. Some officials still favor raising rates at the upcoming meeting, anticipating that geopolitical shocks could push prices higher. A separate report earlier this month indicated the BOJ is considering a significant upward revision to its inflation forecast at the meeting.
Traders have substantially scaled back expectations for a rate move at this meeting, partly because BOJ Governor Kazuo Ueda has not sent clear signals about a hike. In contrast, ahead of the previous two rate increases, the central bank provided strong hints to minimize surprises. As recently as late March, overnight swaps indicated a 73% probability of a hike this month, but those expectations have faded as tensions with Iran escalated. By Tuesday, markets priced in just an 8% chance of a hike next week, though officials reportedly view the outcome as less certain.
In its latest semi-annual Financial System Report, the BOJ provided a detailed risk assessment supporting its cautious approach. The report warned that prolonged instability in the Middle East could systematically damage Japan's real economy through rising energy prices. Surging import costs threaten to sharply reduce corporate cash flows, especially for small and medium-sized firms with limited pricing power, whose profit margins are being rapidly squeezed.
If such pressures persist, corporate default risks could rise broadly, forcing the central bank to prioritize guarding against credit risk when considering monetary tightening. A more severe challenge lies in the Japanese government bond market's unique global role and potential for a "liquidity storm." The BOJ highlighted that overseas hedge funds dominate JGB trading, accounting for 60% of spot transactions and 78% of futures trading.
A sudden surge in global risk aversion could trigger large-scale unwinding by these leveraged funds, amplifying volatility in JGBs that could spill over into global equity and bond markets through cross-asset pricing channels. This interconnectedness underscores the BOJ's heavy responsibility for financial stability and explains why unexpected policy tightening could destabilize fragile markets, forcing the bank to balance inflation control against global liquidity risks.
Communication remains a key focus for the BOJ, which faced criticism after a July 2024 rate hike surprised investors and was linked to that summer's global market slump. With Japan's real interest rates still deeply negative, policy debates and communication are more complex than at other major central banks. Unlike its peers, the BOJ cannot claim a neutral stance while waiting for clearer conditions—Japan's policy rate is the lowest among G7 nations and far below inflation.
The yen continues to trade near 160 per dollar, close to levels that prompted intervention in summer 2024. Further yen weakness could increase inflationary pressures, making the currency's performance a critical factor influencing the BOJ's policy tone at the April meeting.
Comments