"Stagnation" clouds test policy determination: Bank of Japan trapped in dilemma of "resisting inflation" and "maintaining growth"

For most economists, it is a consensus that the Bank of Japan will maintain its monetary policy unchanged this week, but this meeting still has important strategic significance - the authorities are weighing whether preventive measures need to be taken against the surge in oil prices to prevent the risk of overheating inflation. According to sources, Japanese prices have exceeded the Bank of Japan's inflation target of 2% for four consecutive years, and this sustained over-adjustment phenomenon has strengthened the Bank's judgment that "real inflation expectations are finally taking root." Currently, the rising energy prices are further raising input costs for businesses. If more businesses choose to pass on costs to consumers, the Bank of Japan will face a dual policy choice of "supporting the economy to resist supply shocks" and "restraining rapid price increases." This choice will once again confirm that after playing the role of an "experimental exception" for many years, the Bank of Japan is gradually returning to the path of policy normalization, and beginning to face the core contradictions that traditional central banks generally face - how to balance economic growth and price stability. It is worth noting that since the bursting of the asset bubble in the 1990s, Japanese policymakers are facing this kind of dilemma for the first time. Over the previous decades, they were able to prioritize measures to support economic growth without excessive concern for the risk of uncontrollable inflation. Since the 1990s, Japanese policymakers have not faced this kind of dilemma. They were able to prioritize measures to support economic growth without excessive concern for the risk of uncontrollable price increases - the bursting of the asset bubble had laid the foundation for decades of economic stagnation and deflation. Facing the rise in input costs caused by inflation in the raw material market, companies usually choose to maintain product prices stable and absorb the cost impact themselves to maintain market share. To protect profit margins, corporate executives often tightly control wage expenses and investment scale. As a result, workers and consumers gradually form expectations that costs and incomes will come under downward pressure. During that time, supply-side shocks often pushed the Bank of Japan to take increasingly experimental monetary easing measures to cushion economic shocks, including implementing negative interest rate policies and conducting large-scale asset purchases. Since taking office in April 2023, Bank of Japan Governor Kato has been gradually advancing the progressive exit from experimental monetary policy tools. He has consistently emphasized that despite Japan's long experience of inflation, the potential trend of inflation has not yet reached the target level of 2%. However, the recent trend of continuously rising oil prices may quickly reverse this judgment - the transmission of energy costs will accelerate the formation of inflation expectations, and may bring the actual inflation dynamics closer to the policy target earlier than expected. In this context, continuing rate hikes are seen as a key means of maintaining stable price growth. But policymakers need to be wary of dual risks: on the one hand, the rise in borrowing costs will have an additive effect with the potential global economic slowdown caused by the US-Iran conflict, creating downward pressure on Japan's export-oriented economy; on the other hand, if tightening monetary policy too early leads to a deterioration in the output gap, it may weaken the demand-driven momentum for price increases, causing a setback to the inflation trend itself. This intertwined dynamic of contradictions makes policy discussions even more complex. Some officials believe that recent inflation is more of a short-term phenomenon, while others point out that households under pressure from rising living costs do not agree with this notion of "superficial inflation." According to sources, there have been dissenting members within the Bank of Japan's board calling for consecutive rate hikes at the January meeting, but the recent wait-and-see attitude adopted by officials suggests that the decision-making level is not eager to push more members to blindlessly follow suit and raise rates at this month's meeting. Sources further indicate that decision-makers are closely monitoring the developments in geopolitical conflicts and evaluating a range of economic scenarios. Given the highly uncertain and rapidly changing current situation, it may be premature to assert that the uncertainty in the Japanese economy has significantly intensified by the end of the monetary policy meeting on March 18-19. Currently, the market's expectation for a rate hike this month is about 6%, but by the April meeting, this probability is expected to rise to about 63%. According to a survey of observers of the Bank of Japan, April is seen as the most popular timing for a rate hike - more than one-third of respondents predict that a rate hike will be initiated at that time. For policymakers, the core issue is to determine whether Japan has truly escaped the deflationary gravitational pull. If deflation has been overcome, the Bank of Japan may need to accelerate the rate hike process to consolidate inflation expectations and maintain price stability; if the shadow of deflation has not been completely dispelled, a more cautious policy stance is required to avoid premature tightening of monetary policy that could impact economic recovery.