By Leika Kihara
TOKYO, July 31 (Reuters) - The Bank of Japan is set to keep interest rates steady on Friday but signal its resolve to continue pushing up borrowing costs, as mounting price pressures from the weak yen and Middle East conflict risk driving underlying inflation above its target.
The expected hawkish signals from the BOJ would echo those from other central banks focusing on inflation risks from the Iran war-induced energy shock.
Having just hiked in June, the BOJ is widely expected to keep
short-term interest rates steady at 1% at a two-day meeting ending on Friday. Hawkish board member Hajime Takata may dissent and propose a hike to 1.25%, some analysts say.
The BOJ meeting follows that of the U.S. Federal Reserve on Wednesday, at which the board kept interest rates steady but with three dissenters calling for a quarter-percentage-point hike.
Markets are focusing on the BOJ's quarterly outlook report and Governor Kazuo Ueda's post-meeting news briefing for clues on how soon it could raise still-low borrowing costs.
In the report, the board is seen revising up its growth forecast for fiscal 2026 on receding fears of a severe hit from the Middle East conflict, sources have told Reuters.
The board is also likely to cut its inflation forecast due to the effect of subsidies and a drop in oil costs from levels seen in April, they said, though jittery oil markets and rising import costs from a weak yen may keep any downgrade small.
"Although inflation forecasts may be revised lower, stronger growth would reinforce confidence that the economy can withstand further policy normalisation," said Kei Fujimoto, senior economist at SuMi Trust.
"My baseline scenario remains that the BOJ raises rates roughly once every six months. However, given the improving growth backdrop, together with accelerating import-price inflation, the possibility of a faster pace of tightening cannot be ruled out," he said.
WEAK-YEN RISK
The BOJ raised rates to a 31-year high in June and signaled its readiness to tighten further as it focuses on taming price pressures from the energy shock. Most analysts polled by Reuters expect the BOJ to raise rates again to 1.25% by year-end.
The slow pace of rate hikes has been blamed for pushing the yen to a 40-year low, leading to rising import costs that hurt households and retailers.
Ueda will face the challenge of talking down the yen bears through hawkish communication particularly with looming prospects of U.S. rate hikes weighing on the yen's value against the dollar, analysts say.
But pressure from a dovish administration and the potential economic hit from a 7.1-magnitude earthquake in the southern prefecture of Kumamoto, home to plants of major manufacturers and chipmakers, may dampen the hawkish mood, some analysts say.
Core consumer inflation hit 1.6% in June, staying below the BOJ's 2% target for a fifth straight month, suggesting that firms have yet to aggressively pass rising costs on to households. But analysts expect core inflation to climb back above 2% later this year, as the recent surge in producer prices filters through to the broader economy.
(Reporting by Leika Kihara; Editing by Sam Holmes)
