Bank of Japan expected to raise rates this month, sources say

By Leika Kihara

TOKYO, June 4 (Reuters) – The Bank of Japan is expected to raise interest rates this month unless a sharp escalation in the Middle East conflict upends markets, three sources said, as rising fuel costs from the energy shock add to mounting price pressure in the economy.

With hostilities flaring anew in the Iran war, central bank policymakers will scrutinise developments in the Middle East and their fallout on Japan’s economy until the last minute in reaching a final decision, said the sources, who declined to be identified as they are not authorised to speak publicly.

Markets are already pricing in roughly an 80% chance the BOJ will raise its short-term policy rate to 1% from 0.75% at the two-day policy meeting ending on June 16. A hike to 1% would bring the BOJ’s policy rate to levels unseen since 1995.

BOJ Governor Kazuo Ueda all but cemented a June rate hike in a speech on Wednesday, marking a clear narrative pivot toward inflation fighting and opening the door to more frequent increases in borrowing costs.

“Unless there’s a severe escalation in the conflict, the BOJ will probably hike rates in June,” said a source familiar with its thinking, a view echoed by two more sources.

The BOJ declined to comment.

Ueda’s remarks added to a flurry of recent hawkish BOJ signals that heightened the chance of a June rate hike, as concern over inflationary risks from the Iran war pushed bond yields to a near 30-year high last month.

BOJ board members Kazuyuki Masu and Junko Koeda have warned of mounting price pressures in a sign they could join three other hawks in calling for a rate hike as soon as June.

Japan’s wholesale prices rose 4.9% in April from a year earlier, accelerating at the fastest pace in three years, as the Iran war boosted oil and chemical goods prices.

The price pressure is likely to push up core consumer inflation – which has slid below the BOJ’s 2% target due to the effect of government subsidies – well above 2% later this year, analysts say.

RELUCTANT NOD

The BOJ exited a decade-long massive stimulus programme in 2024 and has raised its policy rate several times, including in December, on the view that Japan was on the cusp of durably achieving its inflation target.

Soaring energy costs from the Middle East conflict have complicated the BOJ’s rate decisions, pushing up prices, but also hurting an economy heavily reliant on fuel imports.

Aside from rising energy costs, a renewed slide in the yen has pushed up import costs and broader inflation, adding to the case for an early BOJ rate hike, analysts say.

There are scant signs of explicit opposition from dovish Prime Minister Sanae Takaichi. After a meeting with Takaichi on May 22, Ueda said the premier voiced hope the BOJ sets policy “mindful of the fact the government is taking steps to cushion the blow from rising living costs.”

Former BOJ board member Makoto Sakurai, who retains close contact with lawmakers and incumbent policymakers, described the exchange as a reluctant nod by Takaichi for a June rate hike.

Sakurai told Reuters the premier probably understands that a June hike is inevitable. “It’s now up to Ueda’s determination to push through a hike.”

TAPER PAUSE AN OPTION

At this month’s policy meeting, the BOJ will also review its bond-taper plan running through March next year and lay out a new blueprint for fiscal 2027.

With no change expected to the existing taper plan, markets are focusing on whether the BOJ will keep reducing its monthly bond purchases in fiscal 2027 or maintain the current pace.

Having made some progress reducing its huge balance sheet, the central bank is leaning toward pausing or slowing the pace of its bond taper to avoid causing undue market volatility, two other sources said.

In Wednesday’s speech, Ueda said bond market function has improved steadily as the BOJ slowed purchases under a quantitative tightening plan that has been in place since 2024.

He also said the central bank must be mindful of maintaining bond market stability, as it will take time for investors to buy JGBs, filling the hole left by its diminishing presence.

(Reporting by Leika Kihara; Additional reporting by Takahiko Wada, Takaya Yamaguchi, Makiko Yamazaki and Kentaro Sugiyama; Editing by Jacqueline Wong, Aidan Lewis)