BoJ Preview: Between the rock and a hard place

The BoJ will keep rates unchanged at 0.5% in the May meeting with no change to forward guidance. The BoJ is caught between the rock and a hard place when they are seeing inflation to continuously heating up during a time of uncertainty from U.S. tariffs. It is almost certain the U.S. auto tariff will have a significantly negative impact towards the Japanese economy, still the Shunto wage negotiation has resulted in an expected wage growth of more than 5%. If wage growth translates to domestic demand soon, the BoJ will be difficult to justify further delaying another hike if inflationary pressure comes not from the cost side of equation. Under the current inflationary dynamic and prospect of a U.S.-Japan trade deal within the 90 day grace period, we see the BoJ to hike by another 25bps in the July meeting.

The March headline CPI is still elevated at 3.6% y/y with ex fresh food at 3.2% y/y and ex fresh food & energy 2.9% y/y. The latest picture is showing underlying inflationary pressure building further and is not to be ignored but likely downplayed by the BoJ. Furthermore, the strong result of spring wage negotiation will be supportive for labor cash earning to be above the level BoJ sees that sustainably drive inflation to be above 2%. The risk lies in auto tariff disruption towards the profit margin of Japanese auto industry. It will be critical towards the wage growth data because the auto giants are the one that agreed to the highest wage hike. If the disruption is to be continued, there is a good chance labor cash earning will tread lower for the rest of 2025 and ease headline inflationary pressure but worsen economic development in Japan.

Our central forecast sees the U.S. and Japan to reach a primary agreement within this 90 days grace period and greatly lowers U.S. tariffs. The inflationary picture in the mean time will be hot while BoJ wait and see from the bench as uncertainty lingers. The BoJ has been historically cautious and keep their pace limited in such uncertainty. Thus, they will likely observe the impact of tariffs and trade negotiation for the coming months, before further tightening in July.