Navigating Inflation: Japan's Unique Monetary Policy Stance

Since the onset of the COVID-19 pandemic, major central banks worldwide have aggressively raised interest rates to combat soaring inflation. Now, many are beginning to cut those rates. However, the Bank of Japan (BOJ) has remained an “outlier,” sticking to a different monetary policy playbook.

Despite Japan’s headline and core inflation rates consistently exceeding its 2% target since April 2022, with headline inflation hitting a two-year high of 4% this past January, the BOJ has largely stood pat. Even its so-called core inflation has remained above target since October 2022. In the 14 months since exiting negative interest rate territory in March 2024, the BOJ has hiked rates by a mere 60 basis points. At its most recent June policy meeting, it held its policy rate at 0.5%, stating that “underlying CPI inflation is likely to remain weak, mainly due to a slowing economy.”

In contrast, the U.S. Federal Reserve implemented its first interest rate hike since 2018 in March 2022. During the same year, all major central banks besides the BOJ raised rates.

Rice Prices: A Key Inflation Driver

A primary driver of inflation in Japan is food prices, particularly rice. The country’s rice prices surged in the second half of 2024 and accelerated further in the first half of 2025, largely due to poor harvests in 2023 and 2024. This past May, rice prices jumped by 101.7%, marking the biggest gain in over half a century.

Marcella Chow, a global market strategist at JPMorgan Asset Management, notes that rice accounts for about half of Japan’s core inflation and that future inflation trends are highly dependent on food prices, especially rice.

A Transitory Rice Price Spike?

But despite such sharp price increases, experts suggest that the BOJ won’t shift its policy rate because the central bank views the inflation spike as transitory. BOJ Governor Kazuo Ueda stated at a press conference following the June meeting: “Looking at recent data, consumer inflation is fluctuating around 3%. But this is mainly due to higher import costs and rice prices… We expect that pressure to dissipate.”

JPMorgan’s Chow also points out that Ueda noted that the underlying inflation rate the BOJ focuses on remains below 2%. The BOJ hasn’t publicly revealed the specific components that define “underlying inflation.” “This suggests that the central bank views the recent rice price surge as temporary,” she says, adding that “Ueda doesn’t think the BOJ is behind the curve because the underlying inflation’s upward trend isn’t accelerating.”

Yujiro Goto, head of Japan foreign exchange strategy at Nomura Securities, agrees, arguing that Japan’s current inflation spike, particularly food inflation, is primarily driven by supply issues rather than robust demand.

Goto says, “Therefore, the BOJ judges that the bank doesn’t need to react to the inflation spike, because it’s just cost-push inflation. And for cost-push inflation, rate hikes may not be effective at slowing inflation.”

This view is echoed by Kei Okamura, a portfolio manager at Neuberger Berman, who says that price pressures from food are likely to diminish in the coming months.

Growth Concerns

Concerns about economic growth are another key reason why the BOJ might hold off on hiking interest rates. Minutes from the BOJ's June meeting revealed that some committee members indicated interest rates should remain at their current levels.

Higher interest rates typically help curb inflation, but they can also restrain economic growth.

Chow points out that Japan faces geopolitical uncertainties in the future, including the upcoming Upper House elections and uncertainty surrounding tariffs and trade. She says elections could create political challenges for the Shigeru Ishiba government.

These all pose downside risks to growth, meaning that rate hikes could be delayed rather than brought forward.

Nomura Securities’ Goto similarly argues that growth concerns will cause the BOJ to pause on rate hikes, given that Japan has yet to reach an agreement with the U.S. on trade issues. He states:

“Due to higher tariffs on Japan (a 10% blanket tariff plus industry-specific tariffs on sectors like autos and steel), we expect Japan’s economy to record a small negative growth in July-September, which gives grounds for pausing rate hikes, at least until September of this year.”

Notably, Japan is currently engaged in trade talks with the U.S., but there are no clear signs of a deal. Akimasa Akatawa, the country’s chief trade negotiator, reportedly stated on June 20 that trade negotiations with the U.S. “remain shrouded in mist.” Should the two sides fail to reach an agreement, the U.S. would impose a 25% “reciprocal” tariff on Japanese imports.

Interest rate hikes by the BOJ could strengthen the yen, which would hurt Japan’s typically export-driven economy, reducing the competitiveness of Japanese exports and limiting growth.

The country’s latest trade data show that Japanese exports fell 1.7% year-on-year in May, marking the biggest drop since September 2024.

Due to the sharp drop in exports, Japan’s gross domestic product (GDP) also saw its first decline in a year, falling 0.2% quarter-on-quarter in the three months ending in March.

A Difficult and Narrow Path for Rate Hikes

The BOJ may also be learning from historical lessons. Frederic Neumann, chief Asia economist at HSBC, says that the BOJ experienced decades of sustained deflationary pressures and “several false dawns that led to premature policy tightening.”

As such, the bank is now taking its time to achieve policy normalization. Neumann points out that the BOJ is taking a slow approach to raising rates because rising inflation is primarily driven by a sharp decline in the yen and there are only “nascent signs of a sustained wage-price cycle.”

However, BOJ board member Naoki Tamura stated in a speech on Wednesday that the bank may need to hike rates “promptly” if upside risks to prices increase.

Since April 2022, the yen has depreciated from around 120 to approximately 150 against the U.S. dollar. In 2024, the currency weakened to 161.99 on July 3, its weakest level in about 38 years.

Additionally, Neumann says, “A period of inflation overshoot may be needed to shake Japan’s long-held expectations among households and corporations of limited price gains.”

He says that while the BOJ’s “go slow” strategy is sensible, Japanese monetary officials need to be wary of the risks of normalizing policy too late. “The BOJ faces a difficult and narrow path going forward, needing to hike rates fast enough to prevent inflation expectations from spiraling, but not so fast that it pushes the economy back into its earlier deflationary mire.”