What the Bank of Japan said
Bank of Japan Governor Kazuo Ueda has warned that underlying inflation could exceed the central bank's 2% objective. In remarks read by Deputy Governor Shinichi Uchida, Ueda identified currency swings, Middle East tensions and demand linked to artificial intelligence as risks to the price outlook. The warning comes ahead of the bank's 29–30 October meeting, which will bring updated economic projections. Investors are examining the comments for signals about the pace of future rate increases, though no new decision has been announced. Ueda, who attended the IMF meetings in Bangkok, said on Friday that the central bank will focus on anchoring underlying inflation around its 2% target and won't tolerate any overshoot, stressing anew its resolve to continue raising interest rates.
The language is significant because central bankers choose their words carefully. To say that inflation "could exceed" the target and that the bank "won't tolerate any overshoot" is a signal that the BOJ is prepared to act if prices rise faster than expected. It is not a promise to raise rates at the next meeting, but it is a clear statement of intent: the era of ultra-loose monetary policy in Japan is over, and the direction of travel is toward higher rates.
What the IMF said
The Bank of Japan is "doing the right thing" by normalising monetary policy and may need to raise interest rates faster if inflation rises more than expected, a senior International Monetary Fund official told Reuters. Japan must also clarify how it plans to fund its big spending plans and lay out a medium-term fiscal framework to ease market concerns about fiscal risks, said Krishna Srinivasan, director of the IMF's Asia and Pacific Department. "I would say that they are doing the right thing at this point," Srinivasan said of the BOJ's efforts to lift its policy rate toward levels deemed neutral to the economy. "If inflation rises faster than expected, you have to start tightening faster because you don't want inflation expectations to get un-anchored. It's data dependent," he said in an interview on Friday.
The IMF's message has two parts: support for the BOJ's direction, and a warning about fiscal policy. The fiscal warning matters because Japan has very high public debt, and markets want to know how the government will fund its spending plans — including defence, social security and measures to support households — without undermining confidence. If markets lose confidence in Japan's fiscal path, borrowing costs could rise, which would make both fiscal and monetary policy harder. A clear medium-term fiscal framework, setting out how spending will be funded over several years, would help anchor expectations.
Why inflation is rising in Japan
Several forces are pushing up prices in Japan. First, the weak yen adds to inflation by boosting the cost of raw material imports — Japan imports much of its energy and food, so a weaker currency directly raises prices. Second, Middle East tensions have pushed up oil prices, with Brent crude touching US$110 a barrel, which feeds into transport, heating and manufacturing costs. Third, brisk demand linked to artificial intelligence is driving investment in data centres, chips and energy, adding to demand pressures. Fourth, Japan's labour market has tightened, with workers able to negotiate higher wages after decades of stagnation. Together, these forces have pushed the BOJ to raise rates to a 31-year high of 1.25% in September, following a hike in June. Many analysts expect another rate increase by year-end.
The BOJ's challenge is to distinguish between temporary price shocks — such as a spike in oil prices that may reverse — and underlying inflation that could become entrenched. That is why Ueda spoke about "underlying" inflation, which strips out volatile items to reveal the trend. If underlying inflation is rising because wages and domestic demand are strengthening, the case for rate hikes is strong. If it is driven mainly by temporary external shocks, the case is weaker, because raising rates will not bring down oil prices but will slow the economy. The BOJ's October projections will give a clearer picture of which story dominates.
What markets expect
The remarks came ahead of the BOJ's key policy meeting later this month, when it could keep rates steady but drop hawkish hints that would reinforce dominant market expectations of a December hike. Investors are watching for signals about the pace of future increases. A "hawkish hint" might take the form of upgraded inflation forecasts, or language suggesting that risks are tilted to the upside. Markets also watch the yen: Japan conducted a rare, coordinated intervention with the US on 31 July to prevent the currency's slide to near 40-year lows from destabilising financial markets, and Japan has signalled readiness for further FX intervention if needed. A weaker yen pushes up import prices, which in turn strengthens the case for rate hikes — a feedback loop the BOJ is trying to manage.
Inflationary pressures from the Middle East conflict and brisk AI demand were among the key themes discussed by policymakers gathering for this week's annual IMF meetings in Bangkok. The IMF meetings are where central bankers and finance ministers compare notes on the global economy, and the fact that AI demand and Middle East tensions were central themes shows how those two forces are now shaping monetary policy worldwide, not just in Japan.
What higher rates mean for Japan
Higher interest rates affect Japan in several ways. For borrowers, they mean higher mortgage and loan costs, which can slow spending and investment. For savers, they mean better returns on deposits, which is a welcome change after decades of near-zero rates. For the government, they mean higher debt-servicing costs, which is why the IMF's call for a clear fiscal framework matters. For companies, they mean a higher cost of capital, which can affect investment decisions. For the yen, higher rates tend to support the currency, because they make Japanese assets more attractive to investors. The BOJ must balance all of these effects: raise rates too slowly, and inflation expectations could become unanchored; raise them too quickly, and the economy could slow more than necessary.
For ordinary Japanese households, the most immediate effect of inflation is on daily life: food, energy and transport cost more. Wage growth has helped offset some of that, but not all households have benefited equally. The BOJ's task is to keep inflation close to 2% — not so high that it erodes living standards, and not so low that the economy slips back into deflation, the trap Japan spent decades trying to escape.
Why it matters beyond Japan
Japan's monetary policy matters beyond its borders because Japan is one of the world's largest economies and a major source of global capital. When Japanese rates rise, it affects capital flows, exchange rates and bond markets worldwide. It also matters as a case study in how to exit decades of ultra-loose policy without triggering a recession. Other central banks are watching Japan closely, because the challenges — ageing populations, high debt, energy shocks, AI-driven investment — are shared. Readers can follow our earlier coverage of core inflation above the BOJ target and wholesale inflation and rate hikes for more on Japan's price pressures.
What happens next
The BOJ's policy meeting on 29–30 October will bring updated economic projections and a decision on rates. Markets expect the bank to hold rates steady but to signal that a December hike is likely. Watch for the new inflation forecasts, for any change in the BOJ's language about risks, and for the government's response to the IMF's call for a medium-term fiscal framework. The data will decide the pace: if inflation beats forecasts, expect faster tightening; if it cools, the BOJ can afford to move more gradually.