The Bank of Japan (BOJ) on Wednesday decided to keep rates unchanged despite recent increases in inflation. But the rising consumer costs might be due to transitory issues. And the BOJ underscored that the external situation is becoming more concerning. So, does that mean traders should give up on expecting a rate hike from the BOJ in the near future?
According to economists, the Bank of Japan (BOJ) should raise rates next in July, assuming the current trajectory in inflation and the economy. But a lot can happen over the next three months that could throw those projections off. And one of them is that the tariffs could be deflationary in the case of Japan.
Making the Case To Hold
In his post rate decision press conference, BOJ Governor Kazuo Ueda highlighted the dilemma that the bank was in. First, he said that inflation was threatening to rise. But quickly added that the uncertainty from US tariffs and the global outlook meant it was hard to judge the impact on Japan. Which is his way of saying something similar to what Fed Chair Jerome Powell also said on Wednesday: Predicting where interest rates will go will be particularly hard.
If the experts who decide interest rates are having difficulty, then it will be much harder for traders. But, there are some things that we can fit into general trends to get a better idea of what will happen. And, by extension, what the central bank ultimately will have to do, even if they want to keep their options open for now.
The Reverse Effect of Tariffs
Typically, tariffs raise the cost of goods in a country, which leads to pressure for higher interest rates. But for the country being tariffed, the opposite applies. Since the US is the one putting on tariffs, countries that aren’t adding tariffs could see deflationary pressure. That’s because the higher cost to send goods to countries that have applied tariffs increases supply for countries that don’t have tariffs.
With global interest rates mostly above the target of most central banks, this deflationary pressure would be a boon. But, Japan has a different problem. The currency has been weakened by carry trades as the Bank of Japan (BOJ) kept rates low while other central banks hiked. This means the BOJ needs to keep raising rates to balance out the effect on the currency. But, if inflation falls below target, they are going to have trouble justifying that kind of action. Which could be just what the carry traders are looking for to push the USDJPY higher.
Hold Your Horses
But, that’s not the case right now, with inflation still seen well above target. Meanwhile, businesses are renegotiating wage contracts that are seeing increases of around 5.8% in salaries compared to last year. This could keep inflationary pressure higher for now. But then more tariffs are to come into effect in early April, which could change things.
The consensus among economists is that Japanese February CPI change will accelerate to 4.2% from 4.0% prior. That’s more than double the 2.0% target for the Bank of Japan (BOJ). However, this is seen as the result of more volatile elements, particularly food import costs. The “core-core” rate, which excludes both energy and food, is expected to go down to 2.3% from 2.5% prior. This would likely keep the BOJ on track to hold off on a rate hike at least until the next meeting.
