TOKYO - The Bank of Japan's latest economic outlook has strengthened expectations that another interest rate increase could come as early as September after the central bank kept its policy rate at around 1.0% at its July meeting following a June hike, while placing greater emphasis on the risk that inflation will rise above its 2% target.
Attention instead turned to the bank's quarterly Outlook for Economic Activity and Prices, which sets out its projections for growth and inflation as well as the risks that could affect monetary policy.
Mari Iwashita, executive rates strategist at Nomura Securities and a closely followed BOJ analyst, said the report contained several hawkish changes that suggested policymakers were becoming increasingly concerned about upward pressure on prices.
The BOJ maintained its view that the underlying rate of consumer inflation would reach a level broadly consistent with its price stability target from the second half of fiscal 2026 through fiscal 2027.
However, the report added that inflation could rise clearly above 2% from the latter half of fiscal 2026 before slowing toward around 2% during the later part of the projection period.
Although similar language had appeared in the policy statement issued when the BOJ raised rates in June, this was the first time the risk of inflation overshooting the target had been incorporated into the Outlook Report itself.
The BOJ also expanded the list of major risks affecting the economy and prices. In addition to developments in the Middle East, it highlighted the growth of global demand related to artificial intelligence and fluctuations in foreign exchange markets, particularly the yen's weakness.
The central bank revised its assessment of risks to economic growth, saying they were now broadly balanced. In the previous report, it had judged downside risks to be greater.
Risks to inflation, however, remained tilted to the upside.
The BOJ raised its real gross domestic product growth forecast by 0.1 percentage point to 0.6%. Iwashita said the revisions for fiscal 2027 were particularly significant because the bank raised both its economic growth and inflation projections for that year.
The increase in the fiscal 2027 inflation forecast came despite the BOJ lowering its assumed starting price for crude oil from about $105 a barrel in its April projections to around $80 in July.
That combination suggested that forces other than energy costs were expected to push prices higher, Iwashita said.
One major factor was global AI-related demand, a phrase that appeared repeatedly throughout the report. The BOJ indicated that stronger demand connected to AI was supporting economic growth and contributing to price pressure.
The central bank has also observed that the benefits of AI-related investment are spreading across a broad range of industries and regions, rather than remaining concentrated among a small number of technology companies.
Foreign exchange movements were another prominent concern. While currency fluctuations have long been included among the BOJ's risk factors, the discussion was considerably longer in the July report.
The bank noted that the sharp year-on-year increase in import prices was likely to raise the cost of a wide range of goods, including durable consumer products, and said the effects required close monitoring.
Iwashita compared the transmission of inflation to the flow of a river. Higher import prices appear first upstream, then move into corporate goods prices in the middle of the supply chain, and eventually reach consumer prices downstream.
Import prices and prices charged in transactions between companies have already risen sharply, with increases in corporate goods prices accelerating more quickly than expected.
Based on past patterns, it may take about six months for such pressures to be fully reflected in consumer prices. The growing momentum at the corporate level suggests, however, that the impact on households may not be far away.
Food producers and other companies are also expected to implement further price increases from summer through autumn, adding to the prospect that consumer inflation will strengthen during the second half of fiscal 2026.
The BOJ's revised projections appear to assume that these increases will continue to feed through to consumers and lift inflation during the next fiscal year.
The report's discussion of monetary policy was also unusually detailed. It said the timing and pace of future policy adjustments would depend partly on developments in the Middle East, the expansion of AI-related demand and foreign exchange market movements.
Iwashita described the three factors more simply as oil prices, AI demand and the weak yen.
She also drew attention to the BOJ's use of the word "particularly" before its discussion of the risk that underlying inflation could move above the 2% target.
Such wording is closely watched because the BOJ often uses qualifiers such as "in addition," "however" and "particularly" to signal where policymakers are placing special emphasis.
The report said it was important to stabilize inflation at around 2% so that an overshoot would not later damage the economy. That language suggested the central bank may need to raise interest rates early enough to prevent inflation expectations from becoming established above the target.
Failure to act before inflation accelerated could leave the BOJ open to criticism that it had fallen behind the curve.
The concept of anchoring inflation near 2% was also raised by BOJ Deputy Governor Shinichi Uchida following the June rate increase, reinforcing the view that the central bank has entered a new phase in which controlling upside inflation risks has become more important.
The yen's weakness was repeatedly emphasized both in the Outlook Report and at the BOJ governor's news conference.
Currency market intervention by the Finance Ministry can slow the yen's decline, but its effects may be temporary unless monetary policy also addresses the underlying pressure.
Iwashita said the intervention had effectively shifted responsibility toward the BOJ and increased the possibility of a September rate hike.
At the governor's news conference, the BOJ said it was necessary to pay greater attention than before to upside risks to inflation and that policymakers would conduct a thorough discussion at upcoming meetings.
That statement, together with the stronger language in the Outlook Report, indicated that the BOJ was preparing markets for further policy tightening even though it left rates unchanged in July.
Source: テレ東BIZ
