As oil prices surge, the Bank of Japan considers significantly raising its inflation outlook.

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Under the impact of the Middle East conflict, the Bank of Japan faces dual pressures of rising inflation and slowing growth, making the outcome of the April policy meeting highly uncertain.

On April 14, according to Bloomberg citing sources, Bank of Japan officials may significantly raise their inflation forecasts at this month’s policy meeting, mainly due to surging energy prices after the Middle East conflict. At the same time, the central bank may also lower its economic growth forecast to reflect the drag on Japan’s economy, which is highly dependent on energy imports, caused by worsening trade conditions.

The Bank of Japan will conclude its two-day policy meeting on April 28, during which it will also update its quarterly economic outlook and decide whether to further raise its policy rate from the current 0.75%. At present, expectations of a rate hike have been noticeably hampered. BOJ Governor Kazuo Ueda said in a speech this Monday that the outlook for the Middle East conflict remains uncertain, and he gave no signals of a rate hike. Before the two previous rate hikes, Ueda had issued clear advance notices.

Middle East conflict drives up energy costs, Japan’s inflation expectations set for major upward revision

According to sources, the Bank of Japan may discuss significantly raising this fiscal year’s key inflation forecast from the current 1.9% at this month’s meeting, mainly because since the U.S.–Iran war broke out, accumulated energy price increases have reached about 50%.

Last week, Morgan Stanley MUFG Securities economists forecast that inflation may surge to 4% in the coming quarter. In comparison, in February this year, the core consumer price index excluding fresh food was up only 1.6% year-on-year. Japanese government estimates show that an annual increase in energy prices of around 10% pushes up the monthly inflation rate by a maximum of about 0.3 percentage points.

Japan’s core inflation gauge has remained above the central bank's 2% policy target since 2022, and this shock may further intensify upward inflationary pressures.

Widening internal divisions make the Bank of Japan's rate hike outlook unclear

There are currently two opposing views within the Bank of Japan: one holds that given the ongoing instability in the Middle East, this is not an appropriate time to raise rates; the other believes the central bank needs to proceed with rate hikes to counter rising inflationary pressures. The likelihood that the nine committee members will become more divided in their upcoming decisions is increasing. At the March meeting, the central bank maintained rates with an 8-to-1 vote.

Ueda Kazuo said on Monday that both upside risks to inflation and downside risks to the economy will be monitored simultaneously. Sources say the central bank will closely assess inflation trends and make its final decision accordingly, while continuing to track the latest developments in the Middle East situation.

Although short-term decisions are full of uncertainty, sources say that in terms of medium- and long-term expectations, it is unlikely the BOJ will change its core judgment—that a virtuous cycle between wages and inflation will underpin a moderate economic recovery. This means the central bank’s overall inclination to continue normalizing interest rates remains unchanged.

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