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

Reuters Finance APP — Japan has long hoped to achieve sustainable, moderate inflation to normalize its monetary policy. The recent surge in oil prices driven by geopolitical conflicts in Iran seems to support 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 and, combined with a weak yen, rapidly transmitting 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, providing some buffer against shocks, it cannot reverse the underlying supply-side inflation trend.

Japan-U.S. Summit: Energy Security Under Pressure, Japan Seeks Diversification of U.S. Sources

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

Japanese Prime Minister Fumio Kishida and U.S. President Donald Trump held about an hour and a half meeting 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 now effectively blocked Strait of Hormuz, and expressed dissatisfaction with the U.S. bearing long-term costs for defending the strait.

Kishida condemned Iran-related attacks, emphasized the importance of de-escalating tensions, and explained Japan’s legal restrictions on deploying ships. He pledged to do his best to ensure safe passage within the legal framework.

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

In this meeting, Trump did not request an increase in Japan’s defense spending. 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 been pursuing a healthy inflation driven by wage and demand growth, aiming to create 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 remains bleak: Japan’s real monthly wages fell across the board in 2025, with only a slight positive in January 2026.

Against the backdrop of weak 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, only slightly easing in January, with new upside risks from Middle East conflicts.

Central Bank Dilemma: Balancing Rate Hikes and Growth Stabilization

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 support the yen temporarily, but would harm the fragile economic recovery; maintaining easing measures to support growth could allow 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 consumption boom), which can be prevented by rate hikes; input-driven inflation (cost-push, as in this case), which is less responsive to rate hikes; and excessive money supply (e.g., periods when Japan’s export GDP share is high, leading to currency oversupply due to 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, with the outlook mainly influenced by three key variables: first, Middle East tensions and oil prices, which directly determine the strength of imported inflation; second, Japan’s spring wage negotiations, which will impact whether healthy inflation can truly take hold; third, the BOJ’s April policy guidance, which will directly influence 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 zone.

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

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

(Editor: Wang Zhiqiang HF013)

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