Key facts
- The Bank of Japan is expected to maintain its warning that inflation could overshoot its 2% target.
- Sources indicate the BOJ believes the risks of a severe, oil-driven inflation shock have decreased.
- The central bank will likely highlight lingering inflation risks from the Middle East conflict, AI demand, and a weak yen.
- The BOJ is expected to keep interest rates steady at 1% at its upcoming meeting.
- Core consumer inflation stood at 1.6% in June, remaining below the 2% target.
The Bank of Japan is poised to maintain its warning regarding inflation potentially exceeding its 2% target in its upcoming quarterly outlook report, according to three sources familiar with the central bank's thinking. While acknowledging risks such as the Middle East conflict, robust global AI demand, and a weak yen, the BOJ believes the likelihood of a severe, worst-case inflation scenario has diminished since its April assessment.
In its June report, the BOJ had warned of a "big overshoot in inflation," a sentiment that led to a policy rate hike to 1% in June. The upcoming report is expected to retain language about the risk of "underlying consumer inflation deviating upward from our 2% target." However, the emphasis is shifting towards broader inflationary forces and how firms pass costs to consumers, rather than immediate supply shocks.
Core consumer inflation stood at 1.6% in June, below the BOJ's target for five consecutive months. Despite this, analysts anticipate inflation will rise above 2% later this year as producer price increases filter through the economy. The central bank is expected to keep interest rates steady at its upcoming meeting and may revise its growth forecast upward due to receding uncertainty from the Middle East conflict.
Policymakers are divided on the pace of future rate hikes, with some advocating for faster tightening and others preferring a more gradual approach. Evidence of persistent cost-push inflation could compel the BOJ to act sooner than anticipated. Hawks may also push to advance the projected timeline for achieving stable 2% inflation, currently estimated between October 2027 and March 2028. However, as inflation nears 2%, the relevance of this timeframe may wane, with investors focusing more on financial conditions, the yen's trajectory, and the bank's assessment of inflation risks.