The Bank of Japan is widely expected to keep its policy rate unchanged at 1% when it concludes its two-day meeting on July 30-31, while repeating its warning that inflation could overshoot the 2% target — though with noticeably less urgency than three months ago.

According to three sources familiar with the BOJ's thinking cited by Reuters, the central bank will signal in its quarterly outlook report that the risk of a significant inflation overshoot has not increased since April. The report is one of the BOJ's main vehicles for setting out its inflation and growth projections, so changes in its risk language are closely watched for clues on how quickly policymakers may be willing to tighten further. The shift in tone marks a departure from the April report, which warned of a substantial overshoot driven by uncertainty from the Middle East war following the US-Israeli strikes on Iran on February 28.

Risk Profile Shifts

The BOJ raised its policy rate to a 31-year high of 1% in June following that earlier warning. Now, with the likelihood of a worst-case scenario — in which severe supply disruption triggers a sharp price surge and forces rapid rate hikes — seen as having diminished, policymakers are turning their attention toward the extent to which firms continue passing higher costs through to households.

This refocusing reflects a broader shift away from the direct Middle East fallout toward structural forces including strong global AI-related demand and yen weakness. The central bank is expected to flag lingering inflation risks from these factors alongside rising import costs tied to the soft currency.

One source told Reuters that both upside price risks and downside economic risks appear to have subsided compared with three months ago. Another source said the probability of the BOJ's baseline projections materializing has increased.

Inflation Data and Growth Outlook

Core consumer inflation came in at 1.6% in June, remaining below the BOJ's 2% target for a fifth consecutive month and suggesting that firms have not yet aggressively passed rising costs onto consumers. However, analysts expect core inflation to climb back above 2% later this year as recent producer price gains filter through the economy.

That cost pass-through question is central to the BOJ's policy debate because the bank is trying to distinguish temporary import-driven price pressure from a more durable inflation process consistent with its 2% target. The BOJ is also likely to revise up its growth forecast in the upcoming outlook report.

Rate Path and Board Divisions

Reuters-polled analysts expect the BOJ's next rate hike, to 1.25%, to come sometime between October and December. Nomura Securities strategist Mari Iwashita said that if prices rise in line with BOJ forecasts through the summer and autumn, that would lay the groundwork for the next hike.

The central bank is expected to maintain guidance pledging further rate increases, though board members remain divided on the pace. Hawks are arguing for room to move faster, while others favor a more gradual approach. Evidence of building price pressures could tip that balance, potentially forcing the BOJ to act sooner than markets currently anticipate.

Hawkish board members may also push to bring forward the bank's projected timeframe for achieving stable 2% inflation, currently estimated between October this year and March 2028. However, with inflation already close to target, some analysts argue that the timeframe is becoming less relevant as a policy communication tool.

Yen and Financial Conditions in Focus

For the yen — already under pressure and trading near 40-year lows — any signal on financial conditions and currency depreciation in the report is likely to matter more to markets than the precise inflation target timeframe.

JPMorgan Securities Japan chief economist Ayako Fujita said how the BOJ characterizes current financial conditions, including ongoing pressure on the yen, will be important for gauging the timing of its next move. Currency weakness matters for the inflation outlook because it can raise import costs, while tighter policy can also affect broader financial conditions through borrowing costs and market expectations.

A more sanguine BOJ tone, even alongside a repeated overshoot warning, points to policy continuity rather than a hawkish surprise next week. The central bank's perception that acute geopolitical risk is somewhat contained for now suggests it sees no need to deviate from its current measured approach, even as analysts anticipate a further rate increase before year-end.

---

Earlier coverage:

• Japan finmin Katayama signals readiness for decisive forex action on yen
• Japan warns of faster cost pass-through inflation while BOJ expected to hold rates next week
• Japan core CPI rises 1.6% in June, matching forecast, USD/JPY little changed
• US presses BOJ on rate hikes as yen hits 40-year low ... intervention threat looms