Former Bank of Japan official: Inflationary pressures caused by Middle East conflict may lead to rate hike in July

Senior Bank of Japan Policy Board Member Seiji Adachi stated on Tuesday that due to the surge in oil prices caused by the Middle East conflict, the Bank of Japan’s response to the rising inflationary pressures may lag, making a rate hike in July very likely.

Adachi pointed out that, as shown by last week’s “short-term” survey, corporate five-year inflation expectations have reached 2.5%, indicating that the underlying inflation rate has already met the Bank of Japan’s 2% target. Adachi stepped down from his position as a Bank of Japan Policy Board member in March last year.

He said that the surge in oil prices and supply tensions caused by the Iran conflict are prompting the Bank of Japan to raise its short-term policy interest rate from the current 0.75% as soon as possible.

“With the ongoing Middle East conflict, the risk of the Bank of Japan being slow to respond to inflation has increased,” he said in an interview.

“The Bank of Japan should raise interest rates to a neutral level for the economy as soon as possible,” he added, noting that Japan’s neutral interest rate may be around 1.25%.

However, Adachi stated that the likelihood of a rate hike in April is “50-50,” as the ongoing turmoil in Iran makes Japan’s fragile economic outlook even more uncertain.

He said that based on recent hawkish comments from the Bank of Japan and data supporting further rate hikes, “the Bank of Japan is very likely to raise rates again in April, June, or July.”

“But whether they will raise rates in April will be a difficult judgment because it would mean raising rates prematurely when the impact of the war on the economy is still uncertain.”

He also noted that political factors could complicate the Bank of Japan’s decision.

Adachi said that the appointment of two inflation hawks to the Bank of Japan’s Board of Directors by Prime Minister Shinzo Abe indicates that the current government opposes further rate hikes in the near term.

He stated, “Raising rates would increase corporate borrowing costs, which runs counter to the current government’s goal of increasing investment in growth sectors.”

Adachi predicted that the Bank of Japan might raise rates twice this year, bringing its policy rate to a neutral level for the economy.

He pointed out that if the Middle East conflict persists and triggers a prolonged oil crisis lasting over a year, the Bank of Japan may need to accelerate rate hikes to move real borrowing costs out of negative territory.

“We haven’t reached that point yet,” Adachi said, “but depending on how the conflict unfolds, the Bank of Japan will face a very difficult choice between rising inflation and slowing economic growth.”