By Leika Kihara
TOKYO, April 23 (Reuters) - The Bank of Japan is expected to keep interest rates steady next week but signal its readiness to hike them as soon as June, as a war-driven energy shock puts policymakers on guard against mounting inflation risks.
With markets having priced out the chance of a rate increase, investors are focusing on the BOJ's quarterly outlook report and comments from Governor Kazuo Ueda for clues on how the protracted Middle East conflict affects its rate-hike path.
"The
BOJ will stand pat this time but deliver a hawkish message with an eye on a rate hike in June or July," said Tetsuya Inoue, executive economist at Sony Financial Group.
"Corporate price-setting behaviour has changed, so the BOJ must keep an eye out for signs of second-round effects," he said. "The board's price forecasts will offer clues on how hawkish the BOJ is about the rate outlook."
At the April 27 to 28 meeting, the BOJ is likely to keep its short-term policy rate steady at 0.75% as fading prospects of a near-term end to the Iran war keep markets volatile.
Unlike last year when higher U.S. tariffs forced a pause in its rate-hike cycle, the BOJ will stress its resolve to keep raising rates as the energy shock risks fueling broad-based inflation, said sources familiar with its thinking.
The central bank may tweak its policy guidance pledging to raise rates "in accordance with economic and price improvements," to better communicate its willingness to act flexibly against inflation risks from the war, they said.
Nearly two-thirds of economists polled by Reuters expect the BOJ to raise its benchmark rate to 1.0% by end-June.
VIGILANT TO SECOND-ROUND EFFECTS
The U.S.-Israeli war with Iran has complicated the BOJ's efforts to raise still-low interest rates gradually to levels deemed neutral to the economy, seen by markets at around 1.5%.
Japan's heavy reliance on oil imports makes its economy vulnerable to the hit from surging oil prices and supply disruptions from the effective closure of the Strait of Hormuz.
But the risks of looking through the war-driven price pressure have increased as firms become keener to pass on higher costs including from a stubbornly weak yen, keeping inflation above the BOJ's 2% target for nearly four years.
For now, many within the BOJ do not see a strong chance of Japan facing a sharp wage-inflation spiral, where rising prices prod workers to demand huge wage hikes, which in turn leads to broader, more persistent inflation, the sources said.
But hawks in the board have called for vigilance to the risk of second-round effects which, if left unattended, could force the BOJ to eventually hike rates aggressively to tame inflation.
"Corporate and household behaviour have turned inflationary, which may require the BOJ to speed up rate hikes," one of the sources said.
With surging fuel costs seen hitting corporate profits, the BOJ is set to cut its growth forecast for the fiscal year that began in April in its quarterly report, the sources said.
The board is also seen sharply revising up its fiscal 2026 inflation forecast with rising costs for oil-related raw material already prodding some firms to ponder price hikes, they said.
The BOJ will likely warn of the hit to growth from the war, but retain its view that underlying inflation will progress towards durably hitting its 2% target, the sources said.
While a prolonged closure of the strait would cause severe supply constraints and disrupt production, the BOJ is likely to categorise the possibility as more a risk for now rather than a factor directly affecting its baseline scenario, they said.
In current forecasts made in January, the BOJ expects the economy to grow 1.0% in fiscal 2026 before slowing to 0.8% in 2027. It projects core inflation to hit 1.9% in fiscal 2026 and 2.0% in 2027. Next week's quarterly report will include forecasts for fiscal 2028 for the first time.
(Reporting by Leika Kihara; Editing by Sam Holmes)
