BOJ keeps rates on hold, warns of inflationary pressure from Iran war

By Leika Kihara and Makiko Yamazaki

TOKYO, March 19 (Reuters) – The Bank of Japan held interest rates steady on Thursday but maintained its bias for tighter monetary policy, warning that surging oil prices driven by the Middle East conflict could exacerbate inflationary pressures.

Governor Kazuo Ueda said the BOJ board was somewhat more focused on upside risks to inflation than downside risks to growth from the conflict, keeping alive market expectations for a near-term rate hike.

“Before the Middle East conflict, household and corporate activity had been firm. The government’s stimulus measures will likely underpin the economy,” Ueda told a press conference.

“We will take these points into account in determining the degree to which rising oil prices could weigh on the economy through worsening terms of trade.”

At the two-day meeting ending on Thursday, the BOJ left intact its short-term policy rate at 0.75%. Board member Hajime Takata repeated an unsuccessful proposal he made in January to push up rates to 1.0%, arguing that Japan has already seen inflation durably hit 2%.

Another board member Naoki Tamura also dissented from the BOJ’s view that inflation will durably hit 2% sometime from October, arguing instead the timing could come as soon as April.

“In the wake of increased tension in the Middle East, global markets have been volatile,” the BOJ said in a statement announcing the decision, adding that rising oil prices will likely put upward pressure on consumer inflation.

“Attention should be paid to the impact of rising crude oil prices on the outlook for underlying consumer inflation.”

The BOJ’s decision came in a week crammed with central bank meetings, where policymakers grappled with a policy path muddled by the Middle East oil shock. The Federal Reserve and Bank of Canada kept rates on hold but struck hawkish tones on Wednesday, mindful of the risk surging oil prices could fan inflation.

Ueda offered few clues on how soon the BOJ could raise rates again. But he said its next quarterly review of growth and price forecasts, due in April, will be key as the board would have more data to gauge whether its baseline scenario remains intact, or fresh risks were emerging that warranted a policy response.

“There appeared to be slightly more members who were more mindful of upside price risk than downside risks to growth,” Ueda said on the board’s discussion over the impact of the war.

“If we see risks that we cannot leave unattended, I won’t rule out the chance of shifting policy from a risk management perspective,” he said, signalling the chance of a rate hike if inflationary risks overshoot expectations.

The yen firmed around 159.40 per dollar after Ueda’s remarks as markets viewed them as somewhat hawkish.

“One important thing is that Ueda was not dovish. I was a bit worried he would become very dovish because of uncertainty over the Middle East situation,” said Tohru Sasaki, chief strategist at Fukuoka Financial Group.

“I think a rate hike is possible in April because thinking about the oil price and yen, it’s going to be a very big impact on inflation.”

NEW INDICATOR EYED

The BOJ raised interest rates to a 30-year high of 0.75% in December and has signalled its readiness to keep increasing borrowing costs if Japan continued to progress towards durably achieving its 2% inflation target backed by wage gains.

The surge in oil prices from the U.S. and Israeli war on Iran has come on top of rising import costs from a weak yen, which has kept core inflation above the BOJ’s target for nearly four years.

Finance Minister Satsuki Katayama issued a fresh warning to speculators against pushing down the yen too much, saying authorities were prepared to take action against volatile moves.

Ueda, too, warned that currency moves could have a bigger impact on inflation than in the past, suggesting that a depreciating yen could be among triggers for further rate hikes.

Despite heightened uncertainty in the Middle East, markets see roughly a 60% chance of another rate hike in April.

Ueda also said the BOJ will release a new price indicator by summer that strips away the effect of one-off factors and better measures trend inflation. Analysts believe this move could help the BOJ justify future rate hikes.

The government has implemented various steps to cushion the blow to households from rising costs, such as subsidies to curb utility bills.

“With subsidies and energy swings muddying headline CPI, cleaner trimmed-mean style measures could give markets a better read on underlying inflation and strengthen the case for the BOJ to keep hiking,” said Masahiko Loo, senior fixed income strategist at State Street Investment.

So far, the economy remains in solid shape. Exports rose for a sixth straight month in February and major firms offered big pay hikes in annual wage negotiations, in line with the BOJ’s view Japan was seeing a cycle of wage and price gains kick off.

But Japan’s heavy reliance on Middle East oil may worsen the hit to the economy from rising fuel costs, some analysts say.

(Reporting by Leika Kihara; additional reporting by Tamiyuki Kihara, Kantaro Komiya, Chang-Ran Kim and Satoshi Sugiyama; Editing by Sam Holmes)