BOJ Signals Hawkish Turn: Inflation Risks Rising, Rate Hikes Could Outpace Market Expectations

According to the Bank of Japan's summary of opinions from its July policy meeting, internal concern over inflationary risks has significantly intensified. One member pointed out that, given the core Consumer Price Index (CPI) is now approaching the 2% target and that upside risks to prices are higher than in the past, the pace of future rate hikes could be faster than market expectations.

At the meeting, the BOJ kept its policy interest rate unchanged at 1%, but clearly signaled the possibility of a further rate hike in September.

BOJ members called for demonstrating determination to prevent inflation from overshooting its target and advocated for a more flexible approach—discussing the scale of rate hikes based on changes in overseas financial conditions rather than adhering to a fixed pace. The policy focus has now shifted from "raising inflation to 2%" to "preventing inflation from rising further beyond target."

The yen's movement is a key factor driving rate hike expectations. Last month, the yen fell to a 40-year low against the U.S. dollar, intensifying concerns over import-driven inflation. Market participants have begun pricing in the possibility of earlier rate hikes. Overnight swap markets indicate a roughly two-thirds chance of a rate hike in September, with the probability rising to 96% by October.

BOJ Governor Kazuo Ueda also adopted a hawkish tone in his post-meeting press conference, emphasizing that the price outlook carries significant upside risks. Some members believe that while it remains difficult to precisely determine the "neutral rate" (the interest rate level that neither stimulates nor cools the economy, estimated by the BOJ to be between 1.1% and 2.5%), the current rate is still below the lower bound of this range. Therefore, the BOJ must continue raising rates to lay the foundation for monetary policy normalization.

Going forward, the BOJ stated it will continue closely monitoring the impact of Middle East tensions, artificial intelligence (AI) demand, and exchange rate fluctuations on the Japanese economy.