Bank of Japan Holds Rates Steady as Middle East Tensions Fuel Inflation Fears

The Bank of Japan (BoJ) opted to keep its policy rate unchanged at 0.75% on Tuesday, though the decision revealed growing internal divisions over how to manage escalating price pressures. The move came via a split 6-3 vote, with three dissenting members advocating for a rate hike to 1% to counter upside risks stemming from the conflict in Iran. This geopolitical instability is creating significant supply-side shocks, particularly in energy markets. Consequently, the BoJ significantly revised its core inflation forecast for fiscal year 2026 upward to 2.8%, a substantial jump from the previous estimate of 1.9%. In a stark contrast, the bank downgraded its growth forecast for the same period to 0.5%, down from 1%. The central bank warned that Japan's economic momentum is likely to decelerate as surging crude oil prices crimp corporate profits and erode real household incomes. This comes as Japan narrowly avoided a technical recession in the final quarter of 2025, posting a revised quarter-on-quarter growth rate of 0.3%. Market reactions were immediate, with the Nikkei 225 index sliding 0.5% following the announcement. Fixed-income markets have already shown signs of stress; the benchmark 10-year Japanese government bond yield recently hit 2.496%, the highest level recorded since 1997. While headline inflation remained below the 2% target at 1.5% in March, the BoJ noted that the pass-through of wage increases to selling prices continues. To mitigate the impact of rising energy costs, the Japanese government has implemented gasoline tax cuts and subsidies.