Japan: Policy on hold, but the direction of travel points towards a hike

• The Bank of Japan kept rates unchanged at 0.75%, but the vote split widened to 6–3, signalling rising urgency to tighten compared to March.

• Growth was revised down to 0.5% for FY2026, though the BoJ does not expect a structural recession. Core inflation forecasts were sharply raised to 2.8% for FY2026, driven by elevated energy prices and supply disruptions.

• We see June as a likely window for a rate hike, driven by upside inflation risks from subsidy roll-offs, a weak yen, and potential second-round effects. The Bank of Japan is unlikely to delay tightening unless there is a severe growth deterioration.

• The yen is likely to strengthen modestly, while equities may see near-term volatility. However, Japan’s long-term equity story remains intact, supported by corporate reforms, “Sanaenomics” policies, and the ongoing reflation trend.

The Bank of Japan (BOJ) kept its policy rate unchanged at 0.75% at the April meeting, but the details beneath the decision were notably more hawkish.

The vote split 6–3, with Hajime Takata, Naoki Tamura, and Junko Nakagawa dissenting in favour of a hike to 1.0%. This marks the widest division under Kazuo Ueda and a clear shift from March’s 8–1 outcome, highlighting growing internal pressure to normalise policy.

A three-member dissent is unusual. The hawkish camp argued that energy-driven inflation, exacerbated by Middle East tensions, is pushing prices persistently higher. The majority, however, opted to wait, citing uncertainty around the duration and economic impact of the conflict. Still, the message was clear: the debate is not about whether to hike, but when.

A classic policy trade-off: Growth down, inflation up

The latest outlook underscores BOJ’s dilemma:

Growth: A meaningful downgrade. FY2026 GDP growth was revised down from 1.0% to 0.5%, as higher oil prices weigh on corporate margins, real household incomes, and trade activity. Kazuo Ueda described the risks as “large,” but emphasised that supply-chain disruptions are typically front-loaded, with effects concentrated over a shorter period. While near-term downside risks are evident, the Bank of Japan does not foresee a structural recession, with recovery expected from FY2027.

Inflation: A significant upward revision. The FY2026 core CPI (ex-fresh food) forecast was raised from 1.9% to 2.8%, driven by the surge in oil prices linked to disruptions in the Strait of Hormuz. Core inflation is expected to average 2.5–3.0% in FY2026, before moderating to 2.0–2.5% in FY2027 and returning to around 2% in FY2028.

The simultaneous downgrade in growth and sharp upward revision in inflation highlight the central policy dilemma facing the Bank of Japan, and help explain its decision to adopt a wait-and-see stance until there is greater clarity on how the Middle East situation will evolve.

Table 1: Summary of changes in April’s policy meeting

Indicator	March 2026	April 2026	Interpretations
Policy rate	0.75%	0.75%	Unchanged, maintaining a hold stance at 0.75%.
Vote	8-1	6-3	A wider split, indicating greater urgency to hike compared to March.
GDP Forecast FY2026	1.0%	0.5%	Downgraded; downside risks acknowledged, but no expectation of a deep structural recession.
Core CPI FY2026	1.9%	2.8%	Core inflation expectations revised sharply higher due to elevated oil prices.
Source: Outlook for Economic Activity and Prices (April 2026). Data as of 28 April.

Beneath the headlines: the economy is holding up

Despite macro headwinds from the Middle East oil shock, Japan’s underlying data paints a more resilient and nuanced picture, arguing against excessive pessimism.

March CPI showed headline inflation at 1.5% YoY and core CPI (ex-fresh food) at 1.8%, both above expectations but still below the 2% target. The softness is largely technical, as government electricity subsidies continued through March, artificially suppressing prices. As these subsidies fade, both measures should move closer to 2%, aligning with the Bank of Japan’s target. That said, a sharp near-term spike is unlikely, given ongoing fuel subsidies capping gasoline prices at ~JPY170 per litre, which should limit pass-through.

More importantly, core-core CPI (ex-food and energy) held at 2.4% YoY, pointing to sustained, demand-driven inflation, particularly in services. This is further supported by a third consecutive year of ~5% wage growth from the 2026 Shunto negotiations, alongside continued positive real wage growth in January (+0.7% YoY) and February (+1.9% YoY).Taken together, these data points provide one the clearest signal of underlying demand resilience, even amid heightened geopolitical uncertainty.

Japan’s exports rose 11.7% YoY in March to a record ¥11.0 trillion, marking a seventh consecutive month of growth. While exports to the Middle East plunged 45.9%, reflecting conflict-related disruptions, this was more than offset by strong demand from China (+17.7%), Taiwan (+27.1%), ASEAN (+19.7%) and EU (+18.2%). Exports to the US rose 3.4%, the first increase in four months, suggesting tariff-related headwinds are easing. Crucially, growth in electrical machinery (+21.5%), driven by semiconductors and ICs, highlights that structural demand for chip-related equipment remains intact, largely insulated from the energy shock.

Japan’s oil situation is currently manageable

Japan remains highly dependent on Middle Eastern oil (around 94% of imports), but its response has been proactive, coordinated, and multi-layered, allowing it to hold up better than many regional peers.

The country maintains roughly 245 days of strategic oil reserves, one of the largest supply buffers among major economies, supported by its relatively energy-efficient structure. In the near term, older coal-fired plants have been ramped up from 50% utilisation to full capacity, with approval for 12 months of emergency operation to prevent power shortages.

At the same time, the shock has accelerated a structural shift in energy policy. Japan has 15 nuclear reactors in operation, with three more under expedited review, a notable move away from its post-Fukushima caution and toward strengthening long-term energy security.

Regionally, Japan is also stepping up coordination efforts through the AZEC 2.0 framework, aimed at advancing Asia’s energy transition while reinforcing supply security and economic resilience.

The policy rate path: A June hike is very likely

A three-member dissent signals that the internal debate at the Bank of Japan is becoming more urgent, and that the bar for the next move is lower than the headline hold suggests.

At the press conference, the governor of BOJ, Kazuo Ueda, also outlined the conditions under which the Bank would proceed. A pause in hike would likely require clear and severe economic disruption, specifically meeting the threshold of a “sharp economic worsening.” By contrast, a moderate slowdown, including the already revised 0.5% growth outlook, remains fully compatible with further tightening (Table 2).

In essence, the Board is no longer deciding whether to hike, but whether to move in June or in the subsequent meeting or two.

In our view, June represents the most likely window for a rate hike. Inflation pressures are set to build further as electricity subsidies fully lapse, with core CPI already trending higher toward the 2% target. At the same time, a persistently weak yen, driven by rate differentials, continues to amplify imported inflation. If second-round effects, where firms pass higher energy costs into broader pricing, become more evident, this would provide additional confirmation for tightening. Together, these dynamics are intensifying pressure on the BoJ to act soon.

Table 2: A rate hike would be delayed only in the case of a severe growth deterioration

Scenario	Growth	Inflation	BOJ Response
Base case	Moderate slowdown	Moves in line with forecast	Hike — "if slowdown is not big"
Upside inflation	Limited damage	Overshoots forecast	Hike — explicitly committed
Inflation overshoot	Any trajectory	Clearly exceeds target	Significant tightening — terminal rate could exceed neutral of 1.0-1.5%
Severe growth shock	Sharp deterioration	Any trajectory	Hold — hike conditional on growth risks being "limited"

Our takeaways: Japan remains a market for long-term allocation

Currency: Slightly bullish bias on JPY

While USD/JPY remains at a weak level around 159 on 28 April 2026, the recent “hawkish hold” by the Bank of Japan reinforces a gradual upward pressure on the policy path, providing stronger support for the yen going forward.

At the same time, we see limited downside room, with the 160 level widely viewed as a potential intervention threshold, which should help anchor expectations and reduce further yen weakness.

Equities: Near-term rotation, long-term opportunity intact

In the near term, we do not expect a potential June rate hike to materially weigh on Japanese equities. The tightening cycle is likely to remain gradual and cautious under the base case, and markets have already priced in one to two rate hikes in 2026. Rather than a broad market impact, we see rotation opportunities within Japan. Japanese banks are the most direct beneficiaries of higher rates, as rising yields support net interest margins. In contrast, Japanese REITs are likely to face headwinds from higher financing costs.

For exporters, a stronger yen may reduce currency translation benefits, but the impact is likely to remain limited if the appreciation is gradual, with the yen stabilising around the 145-150 level based on our estimates. Their performance will ultimately be driven by underlying earnings. The current earnings season continues to paint a resilient picture, but we also acknowledge that the Japanese equities could face a pullback if disruptions in the Strait of Hormuz persist into the third quarter, weighing on global growth and external demand.

Despite near-term volatility, the medium- to long-term investment outlook for Japanese equities remains constructive. Key supporting factors include ongoing economic normalisation, continued corporate governance and capital efficiency reforms and a supportive pro-growth policy framework under “Sanaenomics”, survive the rate cycle. Importantly, Japan’s large-scale household savings pool continues to rotate into equities via NISA. With around JPY 6 trillion of net inflows in 1Q26, this provides a durable structural demand floor for the market over time.

We recommend investors to build exposure to Japan equities via the Eastspring Investments – Japan Dynamic AS SGD and the Xtrackers Nikkei 225 UCITS ETF 1D (LSE: XDJP), to capture the ongoing structural re-rating.

Declaration:

This research report was prepared with the assistance of artificial intelligence (AI) tools. iFAST Financial Pte Ltd does not rely exclusively on AI for content generation; the content of this report – including all investment theses, ratings, price targets and conclusions – has been independently reviewed and verified by the research analyst(s) to ensure accuracy and professional integrity.

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.