Central bank minutes show "hawkish tone": if energy shock persists long term, most members support raising interest rates.

Minutes from the Bank of Japan's March meeting show that several policy committee members believe that if the energy impact of the Iran war becomes prolonged and triggers concerns about a second round of inflationary effects, the central bank should consider raising interest rates. The minutes reveal a hawkish bias, which could strengthen expectations in the market for a rate hike as early as June. At the same time, some members warned that an escalation of the Middle East situation could harm the economy through worsening trade conditions and supply chain disruptions. With the multiple pressures of a weak yen and energy dependence, the policy decisions of the Bank of Japan are becoming increasingly challenging. If the energy impact persists, most members support a rate hike Minutes from the Bank of Japan's March meeting released on Thursday show that at the policy meeting on March 18-19, several committee members believed that if the energy supply shock caused by Middle East conflicts continues and leads to concerns about a broader inflationary impact, the central bank needs to take action to raise interest rates. The minutes stated: "Many committee members believe that if the supply shock caused by tensions in the Middle East is temporary, the basic response should be to wait and see its impact. However, if the shock continues and leads to concerns about a second round of effects on general price levels, the Bank of Japan must respond after assessing the impact on inflation expectations and potential inflation." One member even suggested that the central bank should "proceed with raising interest rates at shorter intervals." Another member stated that if there are no clear signs of economic deterioration due to Middle East conflicts, the central bank should "not hesitate" to raise interest rates. This meeting was the first policy meeting since the US killed an Iranian general on February 28. At that time, the Bank of Japan decided to maintain the short-term policy interest rate at 0.75%. At the subsequent April meeting, the Bank of Japan once again stood pat, but internal hawkish divisions highlighted the committee's increasing concerns about rising price pressures. Discussions in the minutes about a rate hike further strengthened expectations in the market for the Bank of Japan to take action as early as June. The surge in oil prices from the Middle East conflict, coupled with a weak yen and inflationary pressures from wages steadily rising, have kept expectations for a rate hike on the rise. Internal divisions: balancing economic costs and inflation risks Despite the prevailing hawkish voices, the minutes also showed internal divisions, reflecting the difficult choices the Bank of Japan faces: on one hand, the energy shock is pushing up short-term inflation; on the other hand, an economy highly dependent on imported fuel is extremely sensitive to soaring oil prices, and premature or rapid rate hikes may suppress the fragile economic recovery. Some committee members expressed deep concerns about the potential damage the energy shock could bring to the real economy. A few members pointed out that the Bank of Japan must pay attention to the potential economic drag resulting from an escalation of tensions in the Middle East through worsening trade conditions and declining corporate profits. The minutes quoted these members as saying: "If the Strait of Hormuz remains substantially closed for a long time, it may put pressure on corporate activities through supply chain disruptions." At the same time, some committee members believed that as businesses become more proactive in passing rising costs onto consumers, the increase in oil prices could lead to a widespread rise in other commodity prices. One member warned that with the more obvious pass-through effects of a depreciating yen, the Bank of Japan "may unintentionally fall behind the inflation curve." The intertwining of a weak yen and energy vulnerability highlights the policy dilemma The continuous weakening of the yen has become a major challenge for decision-makers as it pushes up import costs, partly due to the Bank of Japan's slow pace of raising interest rates. Over the past four years, rising raw material and labor costs have kept the inflation rate hovering near the Bank of Japan's target of 2%. In a scenario with the risk of rising oil prices and a depreciating yen, the Bank of Japan predicts that core inflation rates will remain around 3% for two consecutive years, highlighting the high vulnerability of the Japanese economy to energy shocks. Last week, Japanese authorities intervened in the foreign exchange market to support the yen against the US dollar. However, some analysts warned that the effects of such intervention measures may not be long-lasting considering the strong structural demand for dollars needed to purchase oil. The Middle East war exacerbates inflationary pressures through soaring oil prices on one hand and poses downside risks to the Japanese economy on the other, making the policy outlook for the central bank even more uncertain. Considering the market's perspective, the Bank of Japan's future pace of rate hikes will be a difficult balance between "curbing inflation" and "avoiding economic slowdown," with the significant uncertainty brought by the Iran war likely becoming a key consideration in the bank's decision-making process.