Rate Hikes Ineffective, Letting It Slide More Painful: Bank of Japan's Difficult Choice

Reuters Finance App News — Japan has long hoped to achieve sustainable, moderate inflation to normalize its monetary policy. The surge in oil prices driven by geopolitical conflicts in Iran seems to help reach this goal, but it has also triggered the cost-push inflation that Japan least wants to face.

As an economy nearly entirely dependent on oil imports, over 90% of Japan’s crude oil comes from the Middle East, most of which must pass through the Strait of Hormuz. Escalating tensions in the Middle East threaten its energy lifeline, pushing up import costs. Coupled with a weak yen, this rapidly transmits imported inflation to production and consumption.

Analysts estimate that a sharp rise in oil prices could increase Japan’s CPI by 0.3% to 0.7%, with energy as a key production factor further amplifying overall inflationary pressures.

Although Japan has strategic oil reserves sufficient for 254 days of consumption to buffer shocks temporarily, it cannot reverse the rising inflation trend from supply-side pressures.

Japan-U.S. Summit: Energy Security Under Pressure, Diversification Sought

Japan’s passive position on energy security was evident in the recent Japan-U.S. summit.

Japanese Prime Minister Fumio Kishida and U.S. President Donald Trump held about an hour and a half of talks at the White House. Trump pointed out that over 90% of Japan’s crude oil imports depend on the Middle East, demanding Japan take more responsibility for ensuring navigation safety through the practically blockaded Strait of Hormuz. He also expressed dissatisfaction with the U.S. bearing long-term costs for defending the strait.

Kishida condemned Iran-related attacks, emphasizing the importance of de-escalating tensions. He also explained legal restrictions on dispatching ships and pledged to do his best within the legal framework to ensure safe passage.

Both sides agreed to maintain close communication on the security of the Strait of Hormuz, energy supply stability, and Middle East developments. They also agreed to expand U.S. energy production cooperation, with Japan proposing a joint project to stockpile U.S. crude oil, aiming to diversify sources and mitigate supply risks.

Trump did not request an increase in defense spending during the talks. Both sides confirmed they would advance various cooperation initiatives to strengthen the Japan-U.S. alliance.

Weak Wage Growth, Healthy Inflation Cycle Still Elusive

Since the Bank of Japan exited negative interest rates in 2024, it has pursued a virtuous cycle driven by wage increases and demand, aiming for a spiral of rising wages and prices. Kishida has also explicitly urged the BOJ to abandon inflation driven solely by raw material costs.

However, reality is less optimistic. In 2025, Japan’s real monthly wages declined across the board, only slightly turning positive in January 2026.

Against the backdrop of sluggish wage growth, cost-push inflation only erodes consumers’ purchasing power and hampers consumption recovery, contradicting the BOJ’s original policy intent. Currently, Japan’s overall inflation has remained above 2% for 45 consecutive months, with only a slight dip in January. The Middle East conflict introduces new upside risks.

Central Bank Dilemma: Rate Hikes vs. Economic Stability

Ueda Kazuo has clearly stated that core inflation is accelerating toward the 2% target, but price increases must be matched by steady wage growth.

At the same time, rising oil prices will worsen Japan’s trade conditions and suppress economic performance.

This puts the BOJ in a classic policy dilemma: raising interest rates could curb inflation and temporarily support the yen, but would harm the fragile economic recovery; maintaining easing measures to support growth risks allowing cost-push imported inflation to spread further, increasing yen depreciation pressure.

Market consensus generally believes that rate hikes mainly impact demand and have limited effect on supply-driven inflation. The BOJ is more likely to adopt a wait-and-see approach rather than rushing to raise rates.

It’s worth noting that inflation can be driven by three main mechanisms: demand-pull inflation (e.g., post-pandemic surge in consumption), which can be prevented by rate hikes; input-driven inflation (cost-push), which is the current case and less responsive to rate hikes; and excessive money supply, such as during periods when Japan’s export GDP share is high, leading to currency oversupply from foreign exchange conversions.

Core Logic of Yen Trading: Three Major Variables Drive the Outlook

For yen trading, the current market sees intensified bullish and bearish battles. The key factors influencing the outlook are: first, Middle East tensions and oil prices, which directly determine the strength of imported inflation; second, Japan’s spring wage negotiations, crucial for the realization of healthy inflation; and third, the BOJ’s April policy guidance, which will directly impact rate hike expectations and yield spread trading.

In the short term, the yen is supported by intervention expectations and risk aversion sentiment. In the medium term, it is constrained by the BOJ’s policy dilemma, energy dependence vulnerabilities, and weak economic fundamentals. The currency is likely to fluctuate within a broad range, with 158–160 as a key battleground.

(USD/JPY daily chart, source: Switch to another device)

As of 17:11 Beijing time, USD/JPY is quoted at 15.53/54.

(End of report)

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