The Bank of Japan may stand pat in April: it still maintains a hawkish stance, hinting at a rate hike "at some point."

According to informed sources, in light of the uncertainty caused by the Iran conflict, the Bank of Japan is inclined to maintain its policy rate unchanged next week, but officials still promise to raise borrowing costs at some point. These sources indicate that due to the high volatility in the Middle East situation, economic prospects may still undergo significant changes, so officials believe there is no rush to raise the benchmark interest rate. The above-mentioned sources stated that given the current financial environment is still quite accommodative, even if the final decision on April 28 is to keep the overnight rate unchanged at 0.75%, the Bank of Japan may still maintain its stance of continuing to raise the benchmark interest rate when conditions allow. They also stated that if the economy remains stable, this would increase the likelihood of taking action in June. It is understood that some officials still lean towards raising rates at the upcoming meeting as they anticipate geopolitical shocks will push up prices. According to another report earlier this month, the Bank of Japan is considering significantly raising inflation expectations at the meeting. The sources added that officials will make a final policy decision after closely monitoring the US-Iran conflict until the last moment. Currently, traders have significantly reduced their expectations for rate action at this meeting, in part because Bank of Japan Governor Haruhiko Kuroda has not given a clear signal for a rate hike. Prior to the previous two rate hikes, the bank's management had strongly hinted at them to minimize surprises. In late March, overnight index swaps indicated a 73% likelihood of a rate hike this month, but as the Iran conflict escalated, expectations for a hike gradually diminished. On Tuesday, the market believed the likelihood of a rate hike next week was only 8%, but the sources mentioned above stated that officials do not see this decision as so clear-cut. It is worth mentioning that the Bank of Japan, in its latest semi-annual Financial System Report, provides a deep risk explanation for this cautious stance. The report harshly warns that continued turmoil in the Middle East could lead to systemic disruption of the Japanese real economy through rising energy prices. With the sharp increase in energy import costs, there is a risk of significant reduction in corporate cash flow, especially for small and medium-sized enterprises lacking pricing power, whose profit margins are quickly being eroded by high input costs. If this pressure persists, it could easily trigger a collective increase in default risks in the corporate sector, making it imperative for the central bank to prioritize guarding against the backlash of credit default risks on financial system stability when considering tightening actions such as rate hikes. A more severe challenge comes from Japan's unique position in the global financial landscape and the potential for a "liquidity storm." The Bank of Japan specifically points out that the trading structure of the Japanese bond market is currently highly dominated by overseas hedge funds, with these leveraged funds occupying a high proportion in both the Japanese bond spot and futures markets - accounting for 60% in spot trading and up to 78% in futures trading. If global risk aversion sentiment escalates sharply due to geopolitical conflicts, leading these highly leveraged hedge funds to conduct massive liquidation, the volatility of the Japanese bond market will quickly spill over, potentially triggering a chain reaction of global stock and bond market sell-offs through the global cross-asset pricing mechanism. This "bond market affecting the global" warning not only highlights the heavy responsibility of the Bank of Japan in maintaining domestic financial security but also explains why in the current fragile market environment, any unexpected policy tightening actions may become a trigger to burst the bubble, forcing the Bank of Japan to balance the exceptionally difficult task of suppressing inflation with maintaining global liquidity stability. Therefore, communication with the market remains a focus for the Bank of Japan. The central bank was criticized for its rate hike in July 2024, which caught some investors by surprise and was believed to be related to the global market crash that summer. As Japan's real interest rates remain significantly low, the policy debates and communication efforts of the Bank of Japan are more complex in some aspects than those of other major central banks in the US and Europe. Informants stated that unlike their peers, the Bank of Japan cannot claim a neutral wait-and-see stance while waiting for a clearer situation. Japan's policy rate is the lowest among the G7 countries, far below the inflation rate. The yen against the dollar continues to hover around 160, nearing the levels at which the Japanese authorities intervened in the summer of 2024 to support the yen exchange rate. The ongoing weakening of the yen is likely to be a key factor influencing the Bank of Japan's policy stance at the April meeting, as further weakening of the yen could increase inflationary pressures.