BOJ executive saw need for vigilance to ‘non-linear’ inflation spikes

In May, a Bank of Japan (BOJ) executive noted the central bank's concern over potential "non-linear" inflation spikes, signaling the need for such price reactions to inform monetary policy decisions. The official, Koji Nakamura, pointed out Japan's experience with inflation surges caused by import cost hikes and currency shocks.

At a BOJ-hosted conference in May, Nakamura stressed that persistent inflation risks could prompt gradual interest rate hikes. The BOJ recently increased rates to a 31-year peak of 1%, with further hikes expected this week amid mounting inflation concerns. Central banks generally raise rates to temper demand-driven inflation. However, the pandemic, Russia's Ukraine invasion, higher US tariffs, and the Middle East conflict have shifted focus towards supply-side inflation.

At a panel discussion on central banks' responses to supply shocks, Nakamura questioned whether recent disruptions might become more systematic and compounded by income and wealth disparities, populism, geopolitical tensions, and climate change. He emphasized that while supply shocks should be monitored, frequent shocks should not be dismissed as transitory, as they could elevate underlying inflation and inflation expectations.

Nakamura, responsible for the BOJ's division drafting monetary policy, highlighted Japan's history of experiencing "non-linear" reactions in domestic prices following external shocks, such as steep consumer price increases triggered by import price and exchange rate shocks. The shrinking labor force, leading to wage hikes, also poses a structural concern, not to be overlooked as temporary, Nakamura added.

With Japan exiting its decade-long stimulus program in 2024, the BOJ is determined to maintain rate hikes in response to tight labor markets, rising import costs from a weak yen, and increased fuel prices due to the Middle East conflict, all of which heighten the risk of inflation surpassing its 2% target.