To "leave the door open" for interest rate hikes? The Bank of Japan remains on hold as expected, but the upward revision of inflation forecasts exceeds expectations

According to the Zhitong Finance APP, the Bank of Japan has maintained its benchmark interest rate unchanged and raised its inflation expectations, exceeding market expectations, indicating that the Bank of Japan may soon take measures to raise interest rates. At the same time, the central bank warned that it is still assessing the impact of U.S. President Trump's tariffs. In a statement released on Thursday, the Bank of Japan unanimously voted to keep the overnight lending rate at 0.5% at the end of its two-day policy meeting, in line with expectations.

The nine-member Monetary Policy Committee of the Bank of Japan raised its average inflation expectation for this fiscal year from 2.2% to 2.7% in its quarterly economic outlook report, reflecting the continued rise in food prices, while economists expected a slight increase to 2.5%. Additionally, the committee slightly raised its inflation expectations for 2026 and 2027 and slightly upgraded this year's economic growth expectations.

Although the changes in outlook indicate that the committee led by Governor Kazuo Ueda is not far from the next interest rate hike, the central bank has not explicitly disclosed a specific timeline for the rate increase. Officials may need time to assess the impact of U.S. tariff policies on the Japanese economy and global trade, even if an agreement has been reached between the U.S. and Japan.

The Japanese monetary authorities have adjusted their assessment of the balance of inflation risks, stating that the overall risk is balanced but did not specify a specific period. In the outlook report released three months ago, they only mentioned the downside risks for 2025 and 2026. This again indicates that regulators are considering the possibility of raising interest rates in the future.

The Bank of Japan also adjusted its wording regarding trade uncertainties in its outlook report summary to indicate that such uncertainties are no longer "extremely high" and reiterated that it would raise interest rates if conditions permit. Shortly after this decision was announced, the yen began to appreciate against the U.S. dollar. The yield on 2-year Japanese government bonds rose by 1.5 basis points to 0.835%.

Meanwhile, just a few hours earlier, the Federal Reserve maintained its benchmark interest rate unchanged, and Fed Chairman Jerome Powell lowered expectations for a rate cut in September. Powell stated that there are "many uncertainties" that hindered this rate adjustment. However, Governors Waller and Bowman held a different opinion and voted in favor of a 25 basis point rate cut On July 22, the Japanese government reached a trade agreement with the White House to reduce tariffs on U.S. imports of Japanese cars and most other goods to 15%. This agreement eliminates a key uncertainty faced by policymakers, allowing them to now focus on assessing the impact of tariffs.

The latest outlook report from the Bank of Japan states: "Positive progress has been made in trade and other policies, such as the negotiations between Japan and the United States finally reaching an agreement. However, there are still many uncertainties in negotiations between jurisdictions, and the impact of trade and other policies on domestic and foreign economic activities and prices remains unclear."

If the tax rate remains unchanged, Bank of Japan officials expect to have enough data by the end of this year to consider whether it is necessary to raise interest rates. The Bank of Japan has raised its expectations for the inflation situation, as persistently high living costs have made Japan one of the countries with the highest inflation levels among the G7. Rising food prices, especially the increase in rice prices, have driven up the inflation rate, prompting the bank to examine its impact on the underlying inflation trend.

Tohru Sasaki, chief strategist at Fukuoka Financial Group, stated that the Bank of Japan has raised its CPI forecast for 2026, but the increase is still moderate. They remain cautious about the risks to the inflation outlook, but aside from that, the results are not particularly noteworthy.

Sasaki explained: "If we only look at the current level of inflation, the Bank of Japan has every reason to adopt a hawkish stance. From this perspective, the central bank could quickly raise interest rates at any time. However, the Bank of Japan is still closely monitoring global risks, especially U.S. tariff policies. In fact, Japan and the United States have completely different understandings of the so-called tariff agreement, so there is still a lot of uncertainty in trade negotiations between Japan and the U.S. Additionally, the domestic political situation in Japan is also unstable. Therefore, if Governor Ueda wants to adopt a dovish stance, he can fully use these external and internal uncertainties as a reason; but if he looks at the inflation data, he has ample grounds to turn hawkish. So, at present, he has reasons to lean dovish as well as hawkish."