The Bank of Japan left interest rates unchanged as expected on Tuesday, but warned of cooling economic growth and rising inflation due to the impact of the war in the Middle East.
The BOJ left its overnight call rate guided at 0.75%. But the decision was not unanimous, with three of the bank’s 9-member rate-setting board calling for higher interest rates due to rising inflationary risks.
The central bank said it will “continue to raise the policy interest rate and adjust the degree of monetary accommodation,” especially in the face of rising inflationary risks for the Japanese economy.
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"While the Bank of Japan left interest rates unchanged today, its Outlook report was hawkish and we’re sticking to our forecast that the Bank will hike rates in June," Capital Economics analysts said in a statement. Capital Economics and several other brokerages expect a 25 basis point hike in June.
The BOJ said in a statement that consumer price index inflation is expected to be much higher than initially expected in fiscal 2026, the BOJ said. Headline CPI inflation is expected in a range of 2.8% and 3.0% in 2026, much higher than prior forecasts of 1.9% to 2.0%.
Core CPI, which excludes fresh food and energy prices, is expected between 2.5% and 2.7% in 2026, up from prior forecasts of 2.0% and 2.3%. The print is now seen even further above the BOJ’s 2% annual target.
Japan’s economic growth was likely to decelerate in fiscal 2026, the BOJ said, citing the impact of higher crude oil prices from the war in the Middle East.
Real gross domestic product in fiscal 2026 is now expected between 0.4% and 0.7%, compared to prior forecasts of 0.8% to 1.0%. The BOJ also trimmed its forecasts for fiscal 2027 and 2028.
Capital Economics analysts noted that the BOJ’s GDP outlook was "a touch more downbeat than we had anticipated," and that the central bank appeared especially concerned over inflation deviating further towards the upside.
The BOJ warned that higher oil and energy prices are likely to pass on to consumers and hurt corporate profits, while also dragging on economic growth.
But strength in private spending and steady corporate profits are still expected to help underpin growth in the coming years, the BOJ said.
The central bank raised interest rates by a cumulative 85 basis points since early-2024, when it ended nearly a decade of ultra-loose monetary policy. Markets widely expect the BOJ to hike interest rates further in the coming months, especially in the face of heightened inflation risks stemming from the Middle East conflict.
