Bank of Japan Deputy Governor Shinichi Uchida stated that interest rates may rise if underlying inflation increases alongside economic improvements. The bank will review economic and price developments, including the potential effects of U.S. tariffs.
U.S. tariffs are expected to impact Japan’s economy, possibly lowering prices by cooling economic activity, while also putting upward pressure on prices through global supply chain disruptions.
USD/JPY Market Activity
As of the report, the USD/JPY pair rose by 0.08% to 146.19. The BoJ’s ultra-loose monetary policy began in 2013, focusing on stimulating inflation and economic growth through strategies like Quantitative and Qualitative Easing.
In March 2024, the bank raised interest rates, moving away from its ultra-loose policy. The previous depreciation of the Yen was influenced by the policy divergence with other central banks raising rates to combat inflation. Rising global energy prices and increasing domestic salaries have also driven inflation above the BoJ’s 2% target.
Uchida’s comments mark a clear signal that the central bank isn’t merely looking at domestic milestones but is now increasingly responsive to external risks—particularly those tied to foreign policy decisions. When we examine the potential consequences of the newly imposed U.S. tariffs, two divergent outcomes emerge. On one hand, weaker demand could result in slower business activity and muted consumer spending in Japan, reflecting downward forces on price levels. On the other, higher import costs stemming from disrupted supply chains would likely put pressure on input prices, especially for companies reliant on overseas materials and components.
That dual force places the BoJ in a tight position. While inflation currently sits above the 2% target, largely due to a blend of energy cost inflation and wage growth, the outlook is anything but straightforward. Price stability, the bank’s core mandate, could be tested from opposite ends. If tariffs push raw material costs upward without promoting domestic demand, the result could be an uncomfortable form of cost-push inflation—unaccompanied by healthy economic expansion.
Implications for Currency and Interest Rate Markets
We’ve already seen a policy turn in March with the BoJ’s first rate hike in over a decade. This signalled a shift from a decade-long stance that prioritised easing over tightening, implemented under a framework designed to combat persistent stagnation. However, that does not imply an aggressive path forward. The focus, certainly for now, seems to be gradualism, dependent entirely on inflation’s durability in the coming quarters.
One immediate market effect has been the reaction in the yen. The USD/JPY pair ticked up slightly to 146.19, which may seem modest on the surface, but it represents more than a day’s worth of movement. It points to sustained expectations among currency participants that U.S. and Japanese rates may remain apart for longer. Policy divergence remains a dominant theme—particularly as Powell and his team reaffirm commitments to holding rates higher for long enough to anchor inflation.
So what does this imply if you’re positioned in interest rate or currency-linked options? Volatility in rates is expected to stir movement in yen crosses, especially if inflation numbers surprise on either side. It’s the sort of moment when being short gamma or exposed to unhedged vega risk becomes notably uncomfortable.
Wage dynamics also play into this. We’ve seen base pay revisions in the latest Japanese labour negotiations that are well above average, fuelling expectations that inflation might prove more persistent than temporary. If sustained wage increases embed into corporate cost structures—without productivity gains to offset them—pass-through price changes may follow, allowing the BoJ more room to raise rates without triggering an immediate growth contraction.
From where we stand, the interaction between trade policy and domestic inflation will be front-of-mind in terms of volatility drivers through the second half of the year. Headline inflation data will, of course, receive attention, but core measures and consumer behaviour metrics will be more revealing. Watch services sector pricing and household income closely—they’ll offer a clearer picture of whether price movements are becoming embedded.
Expect implied vols to remain sticky, especially in any maturities tied to central bank statement dates. The real tactical advantage may come from positioning around those events carefully and adjusting not just for data surprises, but for language shifts surrounding policy guidance. Any subtle change in tone from key officials—like a reference to wage support or supply-driven inflation—may offer better forward clues than the surface-level data releases.
Keep cycle sensitivity in mind—rates do not move in a vacuum. If the BoJ sees tariff-driven inflation as transitory but headline pressures appear unchecked, we may experience asymmetric rate decisions that depart from market forecasts. That’s the kind of mispricing that opens up opportunity.
