Tokyo – In a conference hosted by the Bank of Japan (BOJ) in May, Executive Director Koji Nakamura warned that Japan’s inflation has shown “non‑linear” reactions to external shocks and that the central bank must factor these dynamics into future policy decisions.

Supply‑side shocks are no longer transitory

Nakamura, who oversees the BOJ’s monetary‑policy drafting division, told a panel that while central banks traditionally raise rates to curb demand‑driven inflation, the current environment is dominated by supply‑side pressures. He cited rising import costs, a weakened yen and higher fuel prices stemming from the Middle East conflict as key drivers.

“While the basic idea is to look through supply shocks, frequent shocks should not be treated as transitory because they can lift underlying inflation and inflation expectations,” Nakamura said. “Japan has observed non‑linear reactions of domestic prices to external shocks, with consumer prices rising sharply in response to both import‑price and exchange‑rate shocks. Such non‑linearities must be taken into account in the conduct of monetary policy.”

Recent rate moves and future outlook

The BOJ lifted its policy rate to a 31‑year high of 1 % in June, the first increase after a decade‑long stimulus program that ended in 2024. Sources told Reuters the bank is expected to raise rates again this week, aligning with other major central banks that are tightening amid mounting inflation risks.

In addition to external price pressures, Nakamura highlighted a “slow‑moving demographic shock.” A shrinking labour pool is pushing wages higher, creating a structural upward pressure on prices that cannot be dismissed as temporary.

Combining data with anecdotal analysis

The executive stressed that central banks need to blend hard data with anecdotal insights to better capture changing household and firm behaviour. This approach, he argued, will improve the ability to gauge inflation expectations and respond appropriately.

“Central banks need to combine data with anecdotal analysis to better capture changing behaviour of households and firms, and how that could affect inflation expectations,” Nakamura added.

Implications for the Japanese economy

With a tight job market, rising import costs from a weak yen, and higher fuel prices, the BOJ’s commitment to continue raising rates aims to prevent inflation from overshooting its 2 % target. Market participants will be watching upcoming policy meetings closely to see how the bank balances the need for price stability with the risk of slowing growth.

Analysts note that the BOJ’s focus on non‑linear price dynamics reflects a broader shift among central banks toward a more nuanced view of inflation, one that accounts for both demand and supply factors in an increasingly interconnected global economy.

Original reporting: Appleton, WI News Feed (HLL/CB) — read the source article.