Inflation Concerns Drive BOJ Towards Monetary Tightening

A hawkish member of the Bank of Japan (BOJ) indicated that the central bank may need to take "decisive action on interest rates" to combat inflation risks, even amidst ongoing uncertainty regarding U.S. tariffs. This statement reflects the BOJ's growing concern over mounting price pressures.

BOJ board member Naoki Tamura stated that inflation is accelerating at a faster pace than anticipated during the last policy meeting on May 1st. He added that companies may begin to pass on labor costs by significantly raising service prices.

Decisive Action as a Guardian of Stability

"If upside risks to inflation intensify, the BOJ may need to act decisively as a guardian of price stability," Tamura explained at a press conference. In a speech to business leaders in Fukushima earlier that day, he noted that while U.S. tariffs may temporarily drag on Japan's economy and prices, consumer inflation is likely to hover around 2% by fiscal year 2027. "There is a very high possibility that we will achieve our price stability target sooner than expected," he added.

These remarks are considered more hawkish than those of Governor Kazuo Ueda, who emphasized the need to pause rate hikes due to the "extremely high" uncertainty surrounding U.S. trade policy. In its latest May forecasts, the BOJ expects core inflation to remain stagnant for a period before accelerating again during the latter half of the three-year forecast period ending in fiscal year 2027, aligning with its price target.

Impact of US Tariffs

Tamura believes that U.S. tariffs may weigh on, but not derail, Japan's economic recovery, as they primarily impact the manufacturing sector, which accounts for only about 20% of GDP. However, he offered little insight into when the BOJ might raise interest rates, saying the decision will largely depend on the evolution of U.S. tariff policy and its impact on the economy.

"We need more information to assess whether core inflation has reached 2%," Tamura said at a press conference. When asked about the possibility of another rate hike this year, he replied: "I have no preconceived ideas, it could be soon or it could take a while."

It is worth noting that the BOJ ended its decade-long massive stimulus program last year and raised short-term interest rates to 0.5% in January, believing that Japan was on the verge of achieving its 2% inflation target sustainably. Although the central bank has signaled its readiness to further raise interest rates, the economic impact of rising U.S. tariffs has forced it to lower its growth forecast for the fiscal year 2025 from 1.1% to 0.5%, complicating the timing of the next rate hike.

Potential Downgrade in Growth Forecast

Three government sources stated that the Japanese government will consider downgrading its economic growth forecast for the current fiscal year ending in March 2026, due to the impact of U.S. tariffs on global demand. The government had forecast economic growth of 1.2% for this fiscal year at the end of last year, but sources indicated that this figure may be lowered to below 1%. The Japanese government will take the impact of U.S. tariffs into account when determining the final forecast figures by around the end of July, as a basis for drafting the national budget for the following fiscal year.

Adding to the uncertainty surrounding the policy outlook, consumer inflation has exceeded the BOJ's 2% target for over three years, as companies continue to pass on rising raw material costs. Tamura noted that consumer inflation in Japan was stronger than expected in April and May, adding that recent food price increases may be driven by permanent factors such as chronic labor shortages and climate change.

Long-Term Inflation Expectations

He also explained that Japan's medium- to long-term inflation expectations have gradually risen as price increases have become widespread. "I personally think that attention should be paid to the inflation expectations of companies and households, as they are the actual drivers of economic activity. I think these expectations have reached around 2%," Tamura said in his speech. He added: "When the possibility of achieving the price stability target increases, or when upside risks to prices intensify, we may need to act decisively despite increased uncertainty."

At the policy meeting last week, the BOJ kept interest rates unchanged at 0.5%. Tamura, a former commercial banker, was the sole dissenter to the central bank's decision to slow the pace of balance sheet reduction next year, calling for the current pace of bond reduction to be maintained.

A summary of the meeting's opinions released on Wednesday revealed a split among BOJ policymakers: one side emphasized the need to maintain ultra-low interest rates to assess the impact of U.S. tariffs, while the other stressed mounting domestic inflation pressures.