FXTRADING Financial Focus (Asia-Pacific 04/07)BOJ Balances Energy Risks and Rate Hike Expectations

The Bank of Japans latest quarterly regional economic report shows that economic assessments across all nine regions remain unchanged, with most areas still described as experiencing moderate recovery or gradual improvement. From a broad perspective, corporate activity, employment conditions, and parts of consumer spending continue to follow the existing recovery trend. However, feedback from businesses highlights a noticeable rise in external uncertainties. Ongoing tensions in the Middle East have made many firms more cautious when planning future operations.

In another report summarizing views from regional branch managers, the Bank of Japan also pointed to this growing caution. The report notes that companies are not primarily worried about a sudden collapse in demand, but rather about increasing uncertainty on the cost side. Energy prices, transportation costs, and certain raw material prices are all rising, gradually squeezing profit margins. Businesses are also concerned that if cost pressures persist, they will eventually be passed on to consumers, potentially weighing on household spending.

Against this backdrop, the Bank of Japan has not signaled any clear hawkish shift, instead choosing to maintain its existing assessment framework. Market participants have noted that the central bank appears reluctant to provide strong guidance ahead of the next policy meeting. With only three weeks remaining until the April 28 decision, reinforcing rate hike expectations too early could limit policy flexibility.

Even so, overnight index swap pricing suggests that traders still see roughly a two-thirds probability of a rate hike this month. Inflation remains a key factor behind this view. While Japans inflation is not as extreme as in the US or Europe, rising energy costs have once again pushed up price pressures. For an economy heavily dependent on imported energy, sustained high oil prices translate directly into imported inflation.

The report also highlights that some companies have already begun passing rising labor, transportation, and raw material costs into product prices. This trend is particularly evident in industries reliant on imported resources, which are facing the combined impact of a weaker yen and higher oil prices. Some firms are considering further price increases to preserve profit margins. However, businesses are also aware that consumers have limited tolerance for rising prices. After two years of inflation, many households are already experiencing noticeable fatigue, prompting companies to remain cautious in their pricing decisions.

Bank of Japan Governor Kazuo Ueda has repeatedly stated that further rate hikes would only be justified if wage growth continues to broaden and sustainably supports inflation. Based on current regional feedback, wage trends had been largely in line with the central banks expectations before the escalation of Middle East tensions. Many small and medium-sized enterprises have indicated that wage increases in fiscal 2026 will likely remain similar to those in fiscal 2025, when spring wage negotiations delivered the largest pay hikes in over three decades.

If external energy shocks persist, Japan‘s economy may face a situation where cost-push inflation continues while both businesses and consumers have limited capacity to absorb higher prices. Energy prices remain the key variable. Although oil prices have stabilized temporarily due to ceasefire negotiations, they are still about 70% higher than pre-crisis levels, and such cost pressures are unlikely to fade quickly. From FXTRADING’s perspective, the Bank of Japan is clearly striving to preserve policy flexibility. On one hand, it must address the risk of resurging inflation; on the other, it needs to avoid tightening policy too early and disrupting the recovery. In the period ahead, Japans policy path will likely revolve around finding a balance between inflation pressures, energy shocks, and wage growth.

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