At the next Bank of Japan (BOJ) meeting, it is likely to send a warning message that inflation is likely to rise above the BOJ’s 2% target. But the central bankers will likely indicate via their signals that these risks have not escalated much in the last three months, sources close to the thinking at the central bank say.

The central bank will emphasize continuing inflation risks for sale in its quarterly outlook at the two-day meeting that wraps on July 31. The Middle East conflict and strong global demand for artificial intelligence (AI) and the high cost of imports due to the weak yen are the causes of these.

However, the BOJ has seen a reduction in the downside risks it considered in its April report, even with all these factors in play, because there is less prospect of such severe supply disruptions causing “wild price swings,” which would necessitate sweeping interest rate increases. The central bank earlier this year noted in an April warning that inflation could suffer a “big overshoot” due to uncertainties stemming from the Middle East war after U.S.-Israeli attacks on Iran.

Following that warning, the BOJ raised its policy rate to 31-year high of 1% in June saying there was a possibility that the underlying consumer inflation rate would move away from the 2% expansion target.

Focusing on Broader Inflationary Forces and Next Rate Hike

The short-term threats of an inflation shock from oil have now passed, and it’s time to pay attention to the extent to which firms pass rising costs onto households. The move suggests the BOJ is trying to avoid the immediate impact of the Middle East crisis and instead is thinking more about the economic consequences in order to decide when to raise rates again.

June’s core consumer inflation rate was 1.6%, and continued to be below the 2% target for the fifth month in a row. This implies businesses haven’t been pushing costs onto consumers aggressively yet. Analysts surveyed in a Reuters poll, though, did not anticipate core inflation to drop back below 2% later this year, driven by a sharp rise in producer prices which should begin to have an impact on the rest of the economy.

In the event of prices climbing in accordance with the BOJ’s summer and autumn predictions, it will make the process of putting in place the groundwork for the next price hike easier, said strategist Mari Iwashita at Nomura Securities.

The BOJ is likely to maintain its policy rate at 1% at the next scheduled meeting, and revise its growth projection upwards. But the board is split on the pace of the next rate increase. Hawks contend that the central bank has the ability to accelerate its pace and could aim to accelerate the central bank’s predicted timeframe for the inflation rate to hit the 2% target, which it has set sometime between October this year and March 2028. Others want to take a measured approach.

Some analysts think that this issue is becoming less relevant as a policy communication indicator, with investors instead waiting for the bank’s own assessment on financial conditions; the current inflation rate is already near the bank’s target, and this time frame is now in the spotlight. The final straw that will make the difference is a sign of building price pressures. The BOJ’s assessment of the financial status will be key to determining the timing of the next hike, but the pace of yen depreciation will be a key factor, said Ayako Fujita, chief economist at JPMorgan Securities Japan.