The BOJ is in a pretty difficult spot with the current economic situation. Which means it’s also harder for the markets to figure out what will happen. With major forces pushing the Bank of Japan (BOJ)in different directions, it might just be a matter of opinion which way wins out in the end. Friday’s key data could provide some clarification on which side has more leverage.
Japan has been dealing with high inflation for a while now. On top of that is now added one quarter of negative growth. It’s particularly concerning that the negative growth happened even before the massive tariffs were enacted at the start of the second quarter. That could mean Japan is facing a technical recession at the start of the current year.
Which Way To Go?
Normally, inflation and the economy move in tandem. That allows the central bank to either support the economy to get inflation up to its target. Or raise rates to slow down the economy and thus inflation. But low growth and high inflation, or stagflation, means the central bank has to prioritize one or the other option.
With the mandate being to control prices, it would seem that the central bank should prioritize fighting inflation. But, there is a lag time between when policy is enacted and when it affects inflation readings. There is debate among economists how much that time is in any given circumstance, but it is often measured in several months. Which means that the central bank has to worry about overtightening, which could push inflation below target. And then the central bank will also be blamed for the recession as well.
Japan’s Unique Position is a Unique Problem
Japan maintained sluggish growth for decades, and even during the fast recovery period post-pandemic, the economy didn’t overheat. Meaning, the Bank of Japan (BOJ) kept rates low while everyone else was hiking. This brought back currency trading, and with a weak yen, inflation started to creep up. Now with tariffs threatening to hurt the export-driven economy, the BOJ is finding its tools getting increasingly limited.
One thing that it could do, and that has worked in the past, is try to convince the market that it will raise rates, but not actually do so. That gives the benefit of slowing inflation, but avoids the drag on the economy from higher rates. This could explain why many BOJ members, led by Governor Kazuo Ueda, keep talking quite definitively about raising rates in the near future. This contrasts with many other central bankers who have tried to be vague and cite uncertainty from tariffs as reason to not give clear guidance on monetary policy.
What the Data Says
Economists believe a rate hike is in the cards, but not until the final quarter of the year. But, the Bank of Japan (BOJ) has pretty much been as forceful as it can on rhetoric about hiking. Which means that if inflation keeps going up, there might be nothing more it can do but to raise rates earlier than economists anticipate.
Japan’s inflation rate for April is expected to tick up to 3.7% from 3.6% prior. That would be the highest it has been since the middle of 2023. The rise is expected to be due primarily to increases in food prices, however. The so-called “core-core rate” that excludes food and energy costs, is seen staying stable at 2.9%.
