BOJ Sounds Alarm Over Persistent Inflation Risks

Japan's central bank is sounding alarm bells over persistent inflation risks that could prompt interest rate hikes. According to BOJ executive director Koji Nakamura, Japan has seen non-linear reactions of domestic prices to external shocks, with consumer prices rising sharply in response to both import price and exchange rate shocks.

Nakamura noted that these non-linearities must be taken into account in the conduct of monetary policy. He also mentioned a 'slow-moving demographic shock' due to Japan's shrinking labour pool, which is lifting wages and cannot be dismissed as temporary.

The BOJ raised interest rates to 1 per cent in June, the highest level in 31 years, and is set to hike rates again this week. Central banks typically raise interest rates to cool demand-driven inflation, but Nakamura highlighted the need for vigilance over supply-side inflation caused by factors such as the Covid-19 pandemic, Russia's invasion of Ukraine, higher US tariffs, and the Middle East conflict.

Nakamura emphasized the importance of combining data with anecdotal analysis to better capture changing behaviour of households and firms and how that could affect inflation expectations. After exiting a decade-long stimulus programme in 2024, the BOJ has vowed to keep raising rates as a tight job market, rising import costs from a weak yen, and higher fuel costs heighten risk of inflation overshooting its 2 per cent target.