EXCLUSIVE-BOJ is likely to hold off raising rates in April, sources say

The Bank of Japan is likely to hold ‌off ​raising interest rates next week, five sources familiar with its thinking said, as fading prospects of a near-term end to the Middle East war keep the country's economic and price outlook highly uncertain.

While a final decision may be a close call and dependent on developments over U.S.-Iran peace negotiations, the central bank is leaning towards standing ‌pat this month to spend more time gauging the fallout from the conflict, the sources said. "Given so much uncertainty, the BOJ probably would see it feasible to stand pat this month," one of the sources said, a view echoed by another source.

A third source said the BOJ is unlikely to hike rates with markets having priced out the chance of a rate increase this month. The sources spoke on condition of anonymity as they were not authorised to speak ‌publicly. While markets have been reducing bets on a rate rise at the BOJ's April 27-28 meeting, this is the first confirmation of the thinking inside the central bank.

Even if the BOJ were to keep rates ‌steady next week, it is likely to signal its readiness to raise borrowing costs as soon as June in the face of mounting inflationary pressures, the sources said. The protracted Middle East conflict has complicated the BOJ's plan to push up still-low borrowing costs with surging oil prices adding to mounting price pressures, while threatening to hurt an economy hugely reliant on imported fuel from the region.

HAWKISH PAUSE EYED Once seen as a strong possibility, the chance of an April rate hike began to dwindle as fading hopes of an early end to the war kept ⁠markets volatile ​and muddled the economic outlook.

As a result, the central bank ⁠began shifting away from its hawkish communication towards highlighting looming risks to the economic outlook. On April 13, BOJ Governor Kazuo Ueda said uncertainty over the Middle East conflict could hurt factory output, signalling the bank's alarm over the economic hit from the war.

Market bets of an ⁠April rate hike fell below 20% when Ueda failed to give clear signals of such a move in a news briefing in Washington last week, instead saying only that the decision will depend on the duration and scale of the energy shock. While ​the BOJ is seen standing pat next week, it has a strong case to proceed with further rate hikes as soon as a subsequent policy meeting on June 15-16.

Its policy rate, at 0.75%, remains ⁠below levels deemed neutral to the economy. Real borrowing costs are still deeply negative with inflation hovering around its 2% target for nearly four years. Delaying rate hikes for too long could also risk fuelling unwelcome yen declines that push up import costs and broader inflation. "Even if it refrains ⁠from ​hiking, the BOJ likely will clearly reaffirm its intention to continue raising rates and preserve room to hike at the next meeting in June," said Ayako Fujita, chief economist at JPMorgan Securities Japan.

"If concerns grow that Japan will keep policy well below neutral for an extended period, this could fuel upward pressure on long-term yields and downward pressure on the yen through a further rise in inflation expectations," she said. In a quarterly outlook report due ⁠next week, the BOJ will likely cut its growth forecasts and revise up its inflation projections to reflect the impact of the war-induced rise in fuel costs, the sources said.

The central bank is seen roughly maintaining its ⁠projection that Japan's economy will sustain a moderate recovery and ⁠make progress in meeting conditions for further rate hikes, they said. The BOJ ended a decade-long, massive stimulus in 2024 and raised interest rates including in December on the view that Japan was making progress in durably hitting its 2% inflation target.

Governor Ueda has signalled the bank's readiness to keep raising rates if its economic and price projections materialise, but ‌has offered few hints on the ‌pace and timing of future rate increases.