Core inflation to hit 2.5 percent as policy rates rise
The Bank of Japan projects core inflation to reach 2.5 percent in fiscal 2026 before easing toward its 2 percent target, while real GDP growth slows to 0.6 percent. In its July Outlook Report, the central bank confirmed it will continue raising policy interest rates as underlying inflation accelerates.
AI demand buffers oil price shock
The Bank of Japan's Policy Board projects real GDP growth of 0.6 percent for fiscal 2026, rising to 0.8 percent in fiscal 2027 and 2028.
High crude oil prices stemming from Middle East tensions weigh on immediate growth, but expansion in global AI demand and accommodative financial conditions provide support.
The year-on-year rate of increase in CPI less fresh food is expected to accelerate to 2.5 percent in fiscal 2026 before moderating to 2.4 percent in fiscal 2027 and 2.0 percent in fiscal 2028.
Core CPI excluding fresh food and energy is projected at 2.5 percent, 2.6 percent, and 2.2 percent across the respective years.
Tight labor market conditions and base pay increases of around 3.5 percent continue to reinforce a virtuous wage-price cycle.
Negative real rates sustain credit expansion
Following the policy rate increase to around 1.0 percent in June 2026, real interest rates remain in negative territory.
Short-term funding costs stay low relative to corporate return on assets, while bank lending growth has expanded to a range of 6.0 to 6.5 percent.
Upstream cost pressures from crude oil and yen weakness have passed quickly into corporate goods prices, pushing yen-basis import prices up nearly 30 percent.
The central bank noted that upside risks to inflation dominate as firms shift toward active wage and price increases.
Walking the tightrope between oil and AI
The report makes a convincing case that Japan has escaped its decades-long deflationary mindset.
However, attributing near-term price momentum heavily to external energy shocks and AI hype obscures persistent domestic consumption vulnerabilities.
Further policy rate increases will test whether wage growth can outpace inflation once emergency energy subsidies expire.