With high oil prices and rising AI demand driving up energy costs, will the Bank of Japan really take action this time?
2026-05-21 11:50:21
Bank of Japan policy board member Junko Onoda said on Thursday (May 21) that the central bank should raise interest rates at an "appropriate pace" as price pressures from the US-Iran conflict could push core inflation above the 2% target. This statement reinforces expectations of a rate hike as early as June. Onoda also pointed out that the central bank must pay closer attention to the side effects of negative real interest rates, given that oil prices are likely to remain high for an extended period.
Onoda's hawkish stance has introduced potential uncertainty into the recent bullish trend of USD/JPY. From early to mid-May, USD/JPY experienced a continuous rise, achieving seven consecutive days of gains and approaching the 160 level. This surge was primarily supported by two factors: firstly, the ongoing geopolitical tensions in the Middle East strengthened the safe-haven demand for the US dollar; and secondly, market expectations for a Federal Reserve rate hike this year continued to rise, while the Bank of Japan maintained an accommodative stance, keeping the USD/JPY interest rate differential at a high level.
"Considering the situation in the Middle East, I believe core inflation could exceed 2% in the future," Onoda said in a speech to business leaders in Fukuoka. She added that the recent moderate rise in long-term inflation expectations is noteworthy. "I believe that it is reasonable to raise policy interest rates at an appropriate pace to address high inflation, while taking into account economic trade-offs."
These remarks suggest that Onoda may be joining the hawkish camp on the board in supporting interest rate hikes, which would increase the likelihood of the Bank of Japan raising rates at its next meeting on June 15-16. Currently, despite core consumer inflation exceeding the 2% target for four consecutive years, the Bank of Japan is maintaining its short-term policy rate at 0.75%.
Onoda stated that the Bank of Japan must be wary of the downsides of inflation-adjusted real interest rates being far below the neutral level of the economy, such as the potential for unexpected distortions in future resource allocation. She pointed out that given Japan's positive output gap and strong global IT demand, the Japanese economy may avoid a major recession in the coming years. "If a major recession does not occur, we must pay closer attention to the side effects of further declines in real interest rates."
Onoda's remarks followed those of another board member, Masakazu, last week. Masakazu called for a rate hike as soon as possible should the economy not show clear signs of slowing. A series of recent hawkish signals have led the market to price in a 70% probability of a June rate hike. Nearly two-thirds of economists surveyed by the media also expect the Bank of Japan to raise rates next month.
At its April 27-28 meeting, the Bank of Japan kept its short-term policy rate unchanged at 0.75%, but three board members voted against raising the rate, reflecting growing concerns about inflationary pressures from the US-Iran conflict. If Yoichi and Onoda join the three hawkish opponents, it means that five of the nine board members support a rate hike, potentially exceeding the number of doves who support keeping the rate unchanged.
Onoda stated that core inflation is already around 2%, and companies are passing on costs through price increases faster than in the past. If inflation and public expectations of future prices rise further, normalizing monetary policy through interest rate hikes will become even more important.
“Developments over the past month or two may have increased the likelihood of a scenario where crude oil prices remain high,” she said, suggesting that the energy cost increases triggered by the Middle East may not be temporary. She added that strong AI demand may also be pushing up energy prices, meaning that prices for many commodities could rise across the board in the future.
In conclusion, hawkish voices within the Bank of Japan are clearly growing stronger. Junko Onoda's latest remarks, echoing her previous call for an additional rate hike and the three dissenting votes at the April meeting, suggest that the pro-rate-hike camp may now hold a majority on the nine-member board. Market pricing indicates a roughly 70% probability of a June rate hike, and surveys show that nearly two-thirds of economists expect a rate hike next month. Persistently high energy costs due to the Middle East conflict, increased electricity consumption driven by AI demand, and companies' accelerated cost passing all contribute to the risk of inflation overshooting.
If the Bank of Japan does raise interest rates at its June meeting, it will be another policy tightening since the end of its decade-long massive stimulus in 2024 and the subsequent rate hike in December. For the yen, rising expectations of a rate hike could provide short-term support, but Japan's high dependence on oil imports remains a significant variable limiting the central bank's policy space.
Alberto Tamura, head of Morgan Stanley's Japan division, offered a starkly contrasting forecast: if the Bank of Japan fails to raise interest rates in June, it will impact the bond and foreign exchange markets, potentially causing the yen to depreciate further to 170 against the US dollar; conversely, if it does raise rates decisively, the yen could strengthen to around 140.
The market generally believes that foreign exchange intervention alone is insufficient to sustain the yen's support. Since the end of April, Japanese authorities have intervened in the market multiple times, using approximately 10 trillion yen (about US$63.35 billion) to support the exchange rate. However, as Nomura Securities' chief economist Kyohei Morita pointed out, to alleviate the imported inflationary pressures caused by the yen's depreciation, the Bank of Japan needs to raise interest rates in June, as the weakening exchange rate is impacting the domestic economy by increasing import costs.
It is noteworthy that the US has also provided diplomatic space for Japan to raise interest rates. Following his meeting this week with Japanese Finance Minister Satsuki Katayama and Bank of Japan Governor Kazuo Ueda, US Treasury Secretary Bessenter expressed confidence on social media that Ueda could "successfully" guide Japan's monetary policy. This statement was interpreted by the market as tacit approval from the US for Japan to raise interest rates, and that the US prefers Japan to support the yen through interest rate hikes rather than direct market intervention.
At 11:50 Beijing time on May 21, the USD/JPY exchange rate was 158.93/94.
Onoda's hawkish stance has introduced potential uncertainty into the recent bullish trend of USD/JPY. From early to mid-May, USD/JPY experienced a continuous rise, achieving seven consecutive days of gains and approaching the 160 level. This surge was primarily supported by two factors: firstly, the ongoing geopolitical tensions in the Middle East strengthened the safe-haven demand for the US dollar; and secondly, market expectations for a Federal Reserve rate hike this year continued to rise, while the Bank of Japan maintained an accommodative stance, keeping the USD/JPY interest rate differential at a high level.
Key takeaway: Inflation may exceed 2%, interest rate hikes should be "appropriately accelerated".
"Considering the situation in the Middle East, I believe core inflation could exceed 2% in the future," Onoda said in a speech to business leaders in Fukuoka. She added that the recent moderate rise in long-term inflation expectations is noteworthy. "I believe that it is reasonable to raise policy interest rates at an appropriate pace to address high inflation, while taking into account economic trade-offs."
These remarks suggest that Onoda may be joining the hawkish camp on the board in supporting interest rate hikes, which would increase the likelihood of the Bank of Japan raising rates at its next meeting on June 15-16. Currently, despite core consumer inflation exceeding the 2% target for four consecutive years, the Bank of Japan is maintaining its short-term policy rate at 0.75%.
Pay attention to the side effects of negative interest rates: increased risk of resource misallocation.
Onoda stated that the Bank of Japan must be wary of the downsides of inflation-adjusted real interest rates being far below the neutral level of the economy, such as the potential for unexpected distortions in future resource allocation. She pointed out that given Japan's positive output gap and strong global IT demand, the Japanese economy may avoid a major recession in the coming years. "If a major recession does not occur, we must pay closer attention to the side effects of further declines in real interest rates."
Hawkish voices converge: Probability of a June rate hike rises to 70%.
Onoda's remarks followed those of another board member, Masakazu, last week. Masakazu called for a rate hike as soon as possible should the economy not show clear signs of slowing. A series of recent hawkish signals have led the market to price in a 70% probability of a June rate hike. Nearly two-thirds of economists surveyed by the media also expect the Bank of Japan to raise rates next month.
At its April 27-28 meeting, the Bank of Japan kept its short-term policy rate unchanged at 0.75%, but three board members voted against raising the rate, reflecting growing concerns about inflationary pressures from the US-Iran conflict. If Yoichi and Onoda join the three hawkish opponents, it means that five of the nine board members support a rate hike, potentially exceeding the number of doves who support keeping the rate unchanged.
Oil price increases may continue, and AI demand exacerbates energy pressures.
Onoda stated that core inflation is already around 2%, and companies are passing on costs through price increases faster than in the past. If inflation and public expectations of future prices rise further, normalizing monetary policy through interest rate hikes will become even more important.
“Developments over the past month or two may have increased the likelihood of a scenario where crude oil prices remain high,” she said, suggesting that the energy cost increases triggered by the Middle East may not be temporary. She added that strong AI demand may also be pushing up energy prices, meaning that prices for many commodities could rise across the board in the future.
The hawkish camp is expanding, and a June rate hike may be a foregone conclusion.
In conclusion, hawkish voices within the Bank of Japan are clearly growing stronger. Junko Onoda's latest remarks, echoing her previous call for an additional rate hike and the three dissenting votes at the April meeting, suggest that the pro-rate-hike camp may now hold a majority on the nine-member board. Market pricing indicates a roughly 70% probability of a June rate hike, and surveys show that nearly two-thirds of economists expect a rate hike next month. Persistently high energy costs due to the Middle East conflict, increased electricity consumption driven by AI demand, and companies' accelerated cost passing all contribute to the risk of inflation overshooting.
If the Bank of Japan does raise interest rates at its June meeting, it will be another policy tightening since the end of its decade-long massive stimulus in 2024 and the subsequent rate hike in December. For the yen, rising expectations of a rate hike could provide short-term support, but Japan's high dependence on oil imports remains a significant variable limiting the central bank's policy space.
Institutional forecasts and market intervention
Alberto Tamura, head of Morgan Stanley's Japan division, offered a starkly contrasting forecast: if the Bank of Japan fails to raise interest rates in June, it will impact the bond and foreign exchange markets, potentially causing the yen to depreciate further to 170 against the US dollar; conversely, if it does raise rates decisively, the yen could strengthen to around 140.
The market generally believes that foreign exchange intervention alone is insufficient to sustain the yen's support. Since the end of April, Japanese authorities have intervened in the market multiple times, using approximately 10 trillion yen (about US$63.35 billion) to support the exchange rate. However, as Nomura Securities' chief economist Kyohei Morita pointed out, to alleviate the imported inflationary pressures caused by the yen's depreciation, the Bank of Japan needs to raise interest rates in June, as the weakening exchange rate is impacting the domestic economy by increasing import costs.
It is noteworthy that the US has also provided diplomatic space for Japan to raise interest rates. Following his meeting this week with Japanese Finance Minister Satsuki Katayama and Bank of Japan Governor Kazuo Ueda, US Treasury Secretary Bessenter expressed confidence on social media that Ueda could "successfully" guide Japan's monetary policy. This statement was interpreted by the market as tacit approval from the US for Japan to raise interest rates, and that the US prefers Japan to support the yen through interest rate hikes rather than direct market intervention.
At 11:50 Beijing time on May 21, the USD/JPY exchange rate was 158.93/94.
- Risk Warning and Disclaimer
- The market involves risk, and trading may not be suitable for all investors. This article is for reference only and does not constitute personal investment advice, nor does it take into account certain users’ specific investment objectives, financial situation, or other needs. Any investment decisions made based on this information are at your own risk.
