Amid concerns over escalating inflation due to conflict in the Middle East, the Bank of Japan is expected to continue its monetary policy normalization. In a recent survey conducted from May 7 to 14, 65% of responding economists (40 out of 62) anticipate the central bank will raise interest rates by 25 basis points in June, bringing the benchmark rate to 1%. This outlook is largely consistent with the results from April's survey.
All but one of the 62 economists surveyed expect the Bank of Japan to implement a rate hike before the end of September. Furthermore, the survey median indicates the benchmark rate is projected to reach 1.25% in the fourth quarter of this year and climb further to 1.50% by the third quarter of 2025, aligning with last month's forecasts.
Additionally, nearly three-quarters of the economists surveyed believe that persistent inflation over the next 12 months poses a greater threat to Japan's economy than a slowdown in demand. Yosuke Matsuo, a senior market economist at Mizuho Securities, commented, "Given that the economic, price, and wage conditions supporting a rate hike are still in place, we view the June meeting, approximately six months ahead of the December 2025 meeting, as the most likely timing for the next hike."
The door for a June rate hike appears open. Last month, the Bank of Japan held its policy rate steady at 0.75% to assess the impact of the Middle East conflict. However, three of the nine members of the Policy Board dissented, advocating for an increase to 1%, signaling growing vigilance among policymakers regarding inflationary pressures stemming from energy shocks related to the conflict.
Kazuo Ueda, a Policy Board member who voted to maintain rates last month, has recently adopted a more hawkish stance, calling for an early rate hike. Ueda stated on Thursday, "I judged at the time (April) that there was no need to rush into a hike, but if data shows no clear signs of an economic downturn, we should act sooner." This suggests he may join the hawkish camp and vote for a hike next month.
Economists' expectations for a potential June rate hike are echoed in the minutes from the Bank of Japan's April meeting. The minutes revealed that several Policy Board members argued for an early rate increase during the meeting, with one member explicitly mentioning the possibility of a hike in June.
According to the minutes, one member noted, "Even with lingering uncertainties over developments in the Middle East, it is highly likely the Bank of Japan could start raising rates from the next meeting." Another member's view stated, "While there is no need to rush at this stage, the bank should move to raise rates as soon as possible, provided the economy shows no clear signs of slowing down." A further opinion highlighted that the current policy rate remains well below the economy's neutral rate, necessitating steady hikes every few months, and that the pace should be accelerated decisively if inflation risks rise further.
The minutes also indicated that many members expressed concerns that the Middle East conflict is intensifying inflationary pressures, increasing the risk of second-round effects and potentially bringing forward the timeline for achieving the 2% underlying inflation target. One member was quoted saying, "With price expectations being revised up significantly and uncertainty over the Middle East situation remaining high, all scenarios point to risks of further price increases." The member added, "Moreover, if supply-side constraints materialize, they would exert extremely strong upward pressure on prices."
Data released last month showed Japan's core inflation rate, excluding fresh food, accelerated for the first time in five months in March, rising year-on-year to 1.8% from 1.6% in February. This increase was influenced by concerns over rising energy prices due to the Middle East conflict. The Bank of Japan also revised up its core inflation forecast for fiscal year 2026 (April 2026 to March 2027) to 2.8% from the 1.9% projected in January.
Notably, the Organisation for Economic Co-operation and Development (OECD), in its Japan Economic Survey released Wednesday, provided a fresh projection that the Bank of Japan's policy rate is expected to reach 2% by the end of 2027. The OECD noted that if inflation remains around 2%, the current policy rate is still at the lower bound of the neutral rate range, and the central bank should continue gradual hikes to guard against economic overheating risks. This 2% terminal rate forecast is more hawkish than the consensus among economists in the aforementioned survey and more aggressive than the view of the International Monetary Fund (IMF), which estimates the terminal rate for Japan's current tightening cycle to be around 1.5%.
However, the Bank of Japan's progress in normalizing monetary policy may face constraints from the government. A Japanese government advisory panel has warned that, given deteriorating corporate financing conditions and uncertainties stemming from the Middle East situation, the central bank should exercise caution in setting monetary policy. This statement is seen as a direct reminder to Bank of Japan Governor Kazuo Ueda, suggesting that pushing for a rate hike in the near term, particularly at the upcoming policy meeting next month, could encounter stronger policy headwinds.
A rate hike could also provide relief for the yen. Following the Bank of Japan's decision to hold rates steady in April, the Japanese government was subsequently compelled to intervene multiple times in the foreign exchange market to support the yen after it breached the 160 yen per dollar level. The central bank is facing increasing pressure, as many believe the approximately 10 trillion yen (about $63.35 billion) spent on recent interventions to curb the yen's decline will have limited effect without accompanying tighter monetary policy.
Unlike its counterparts in the United States and Europe, Japan's current policy rate of 0.75% remains below the "neutral rate" that neither stimulates nor restrains economic activity. With inflation around 2%, maintaining deeply negative real interest rates could lead to economic overheating and further weaken the yen.
Hiroshi Namioka, chief strategist at T&D Asset Management, stated, "Japanese authorities are trying to curb yen depreciation by signaling readiness to intervene, but considering negative real interest rates and the potential for high oil prices to worsen the trade balance, the effect may be limited." Kyohei Morita, chief economist at Nomura Securities, added that the Bank of Japan is also inclined to hike in June to address upside inflation risks stemming from yen weakness, as a weaker yen raises import costs and harms the Japanese economy.
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