Ueda warns of Middle East impact on Japan's inflation
Bank of Japan Governor Kazuo Ueda discussed the outlook for Japan's economic activity and prices, emphasizing the impact of increased Middle East tension. Speaking at the Kisaragi-kai Meeting in Tokyo, he outlined the central bank's thinking on future monetary policy.
Oil shock's ripple effect
Governor Ueda highlighted the substantial rise in crude oil prices since late February, driven by increased Middle East tension.
For Japan, a commodity-importing economy, higher crude oil prices lead to a deterioration in the terms of trade, increasing income outflow to overseas economies.
Japan depends on the Middle East for over 90 percent of its crude oil, with mineral fuel imports amounting to about 3 percent of nominal GDP last year.
This rise is expected to squeeze corporate profits and households' real income.
The pass-through of these price increases is projected to spread relatively quickly from upstream petroleum products to intermediate goods, eventually reaching final goods and services within about a year.
Ueda noted that the dispelling of Japan's deflationary mindset and more active wage- and price-setting behavior suggest a faster and wider price pass-through than in the past.
Growth decelerates, inflation rises
Taking into account the Middle East situation, Japan's economic growth is expected to temporarily decelerate in fiscal 2026, though it will continue to grow moderately, supported by high corporate profits, government measures, and accommodative financial conditions.
Growth is projected to pick up again from fiscal 2027 as adverse effects wane.
On the price front, the year-on-year CPI increase is likely to rise significantly in fiscal 2026, primarily due to higher energy and goods prices.
Underlying CPI inflation, excluding temporary factors, is expected to gradually reach a level consistent with the 2 percent price stability target between the second half of fiscal 2026 and fiscal 2027.
Risks to this outlook include prolonged Middle East turmoil leading to sustained high crude oil prices, which could cause economic growth to deviate downward and inflation upward.
Conversely, a swift resolution could lead to upward deviation in growth and downward deviation in CPI.
BoJ's tightrope walk
The renewed crude oil shock presents a significant test for the Bank of Japan's nascent policy normalization.
While the BoJ has gradually raised rates to 0.75 percent, the speed and breadth of price pass-through could challenge its baseline inflation outlook.
The central bank faces a delicate balance between supporting growth and containing imported inflation, potentially necessitating further adjustments.