Bank of Japan Governor Kazuo Ueda said underlying inflation is approaching the central bank’s 2% target, strengthening the case for further interest rate increases as strong global demand for artificial intelligence boosts investment, exports and prices.
Speaking before parliament on October 19, Ueda highlighted mounting inflationary pressures from Japan’s tight labor market, a moderate economic recovery and rising raw material costs linked to the Middle East conflict. He warned that strong global AI demand was increasing capital expenditure and exports, pushing prices higher across a broad range of goods.
Ueda said adjusting interest rates at an appropriate pace would help prevent sharp increases in government bond yields. With underlying inflation approaching the target and financial conditions remaining accommodative, delaying necessary policy adjustments could fuel market concerns about excessive inflation and push long-term borrowing costs higher.
The Bank of Japan’s next two-day policy meeting concludes on October 30, when policymakers will publish updated quarterly economic growth and inflation forecasts. These projections are expected to provide important clues about the timing of the next rate increase.
Although the central bank raised rates in September, many policymakers reportedly favor assessing the effects of previous increases before tightening further. Market expectations currently lean toward rates remaining at 1.25% this month, while leaving open the possibility of an increase to 1.5% as early as December.
Fiscal policy is adding another layer of uncertainty. Japanese government bond yields have risen amid expectations of further monetary tightening and concerns that Prime Minister Sanae Takaichi’s spending plans and proposed tax cuts could worsen the country’s already strained public finances.
Ueda said higher government expenditure could increase prices and wages by stimulating demand, although spending that expands Japan’s productive capacity could moderate inflation over the longer term. He also reiterated that emergency bond purchases would be reserved for sharp yield increases or serious market dysfunction.
Takaichi rejected claims that her administration had triggered the sell-off in the yen and government bonds, saying the government would carefully assess spending levels and control debt issuance. She argued that strengthening the economy could help restore confidence in the yen.
The International Monetary Fund has urged the BOJ to continue raising interest rates while calling on the government to establish a medium-term fiscal framework. Investors remain concerned about how Japan will finance its proposed spending and tax reductions.
The central bank now faces the challenge of containing inflation without destabilizing bond markets or placing excessive pressure on economic growth. Its upcoming forecasts and policy guidance could shape expectations for Japanese interest rates, government bond yields and the yen in the weeks ahead.
