The Bank of Japan (BOJ) kept the short-term interest rate unchanged at 0.5% at its meeting on March 19th, in line with market expectations. However, Governor Kazuo Ueda's speech revealed the central bank's high vigilance towards food driven inflation, suggesting that the timing of interest rate hikes may be earlier than expected.

Despite the Trump administration's extensive tariff policies on trading partners adding uncertainty to the monetary path, signs of rising domestic prices and wages are driving the BOJ to steadily tighten policy, and expectations of interest rate hikes may provide a boost to the yen.

In February, the core CPI (excluding fresh food) increased by 3.0% year-on-year, exceeding the 2% target for the 35th consecutive month. Food prices surged by 5.6% year-on-year, accelerating for the seventh consecutive month. Among them, rice prices surged by 81.4%, the fastest growth rate in nearly 50 years.

The global cost of goods has skyrocketed due to the uncertainty of the geopolitical situation, coupled with the weak yen pushing up import costs, and coupled with last year's high temperatures and production cuts, food inflation remains high.

Kazuo Ueda said, "The long-term rise in rice prices may affect inflation expectations and public sentiment, and this risk cannot be ignored. We need to closely monitor it." He changed his previous stance of downplaying food inflation and emphasized its lasting impact on potential inflation, becoming a key consideration for the pace of interest rate hikes.

During the meeting, Ueda made a rare disclosure that some committee members "emphasized the need to be vigilant about the risk of rising prices", indicating that internal concerns about inflation have intensified. He added, "If the upward risk of potential inflation increases, it will become a reason to accelerate the adjustment of monetary support

This hawkish statement indicates that BOJ is not afraid of the global uncertainty caused by Trump's tariffs and is determined to anchor inflation expectations through interest rate hikes. The next quarterly outlook report will be released at the meeting from April 30th to May 1st. Ueda stated that it may partially include the impact of tariffs and does not rule out the possibility of interest rate hikes at that time.

Naomi Muguruma, Chief Bond Strategist at Mitsubishi UFJ Morgan Stanley Securities, analyzed: "BOJ does not want the market to excessively cool down on expectations of recent interest rate hikes. Trump's policies are against the wind, but once the tailwind becomes apparent, the central bank is eager to take action to ensure that interest rate hikes do not trigger any surprises

The increase in wages in the domestic economic background provides support for inflation expectations. The average salary (excluding bonuses) for the three months ending in January increased by 5.9%, but inflation in the service industry was only 1.3%, which has not yet significantly reflected wage pressure. Although the long-term inflation expectation has not deviated from the 2% target, the sustained rise in food prices may change public expectations.

An anonymous BOJ source said, "If food prices continue to rise, it may substantially change people's views on future prices, proving the rationality of interest rate hikes." Another person added that the central bank cannot control supply shocks, but their persistence is key.

The recent performance of the Japanese yen has been weak, with the US dollar/yen rebounding to 149.77 on March 24th, dragged down by the rise in US bond yields to 4.2770%. However, BOJ hawkish signals may provide rebound momentum for the yen.

If the expectation of a rate hike in May heats up, the USD/JPY may fall back to the 145-147 range. The weakness of the yen exacerbates import inflation, and raising interest rates can alleviate this pressure by boosting the exchange rate.

If the BOJ raises interest rates early, the Japanese yen may receive support in the short term due to the narrowing of interest rate differentials, but the magnitude depends on US policy trends, "said Luftwaffe analysis In the long run, if Trump's tariffs push up global prices, the yen's safe haven nature may further strengthen, but it needs to break through the psychological barrier of 150.

Compared to the Federal Reserve and the European Central Bank, which tend to lower interest rates, BOJ has chosen to steadily raise interest rates due to domestic inflation stickiness. According to a Reuters poll, most analysts expect the next interest rate hike to be in the third quarter (July), but some observers believe that the conditions for the May 1st meeting are already met.

Nobuyasu Atago, Chief Economist of Lotte Securities Economic Research Institute, said, "Ueda's speech made me feel that May may be a 'live meeting'. If food inflation is not intervened, the central bank needs to take action." He pointed out that the long-term rise in commodity prices due to frequent purchases is enough to trigger policy responses.

market outlook

In the short term, BOJ may remain on the sidelines at the April meeting to assess the impact of Trump's April 2 tariff policy. If the February CPI (released on March 26th) continues to exceed expectations, the probability of a rate hike in May will increase, and the interest rate may rise to 0.75%. The Japanese yen may rebound to 147 in the short term due to expectations of interest rate hikes, but if the global trade shock intensifies, safe haven demand may push down the USD/JPY to below 145.