Middle East War Clouds Bank of Japan April Rate Outlook

A weakening yen, rising sovereign bond yields, expansionary fiscal policy under the new prime minister, and the ongoing war in the Middle East have complicated efforts to unwind quantitative easing (QE) and normalize monetary policy.

Before the conflict escalated, markets assigned roughly 70% odds of a rate hike this month. Those probabilities have since collapsed, with traders now pricing in less than 5% chance of an April move and around 60-70% odds for June. Sources indicate a hold is the base case as officials assess the war's fallout, though the BoJ could still decide for further tightening.

Oil shock tests Japan's resilience

Japan imports roughly 90% of its crude oil from the Middle East, leaving it highly exposed to supply disruptions. The war initially drove retail petrol prices as high as ¥190 ($1.19) per litre. They have since retreated to ¥167 ($1.05), near November 2025 levels.

The country entered the crisis with 254 days of oil reserves and has released supplies equivalent to 45 days of domestic consumption. Subsidies to wholesalers – a tool used sporadically since the pandemic – have provided further cushioning.

Inflation shows early war effects

March 2026 nationwide consumer price index (CPI) data, released around 24 Apr, rose 1.5% year-on-year from 1.3% in February. Core CPI (excluding fresh food) accelerated to about 1.8%. Tokyo's core CPI, a leading indicator, stood at 1.7%.

The BoJ tracks a custom gauge that strips out "institutional factors" – primarily government subsidies and support for energy, education, and travel – to reveal underlying price trends. This measure rose 2.2% in February, above the standard core CPI of 1.6%, signalling persistent pressures.

Faced with a supply-side shock largely beyond its control, the BoJ will focus on inflation expectations and second-round effects via wages. Its March opinion survey showed 84% of households expect prices to rise over the next year, down slightly from 86% previously.

Wages grew 1.9% year-on-year in February. Labour unions have secured 5% or higher increases in recent years. If spent, this could support private consumption – roughly half of gross domestic product (GDP) – and reinforce inflation. Nevertheless, real household spending has declined for three consecutive months amid consumer caution.

Business sentiment splits

The April Reuters Tankan survey showed manufacturing confidence weakening sharply. The index fell 11 points to +7, the largest monthly drop in over three years, as sectors tied to Middle East materials suffered most. Non-manufacturing rose from 25 to 31, supported by construction, real estate and information technology.

Fiscal expansion strains markets

Parliament approved a record ¥122tn ($760bn) budget earlier this month. Funding the deficit requires ¥30tn in new debt issuance, about one-quarter of total revenue. This expansionary stance has raised concerns given Japan's high public debt levels.

Yields have climbed, with the 30-year Japanese government bond (JGB) reaching 3.70% and the 10-year note hitting 2.40%, up from 1.3% a year ago. The yen has hovered just below 160 per dollar.

Tightrope ahead for policymakers

BoJ minutes and comments reflect the balancing act. Policymakers view current monetary conditions as still accommodative, with past rate hikes impacting businesses less than labour shortages or material costs. Real interest rates remain significantly negative. The board worries about falling behind the curve amid active wage-setting and yen weakness.

Governor Kazuo Ueda struck a cautious tone, citing "lingering uncertainty over the Middle East" and the need to scrutinize impacts on the economy, prices, and financial conditions. "The current situation involves a significant shock from rising energy prices. This creates both upside risks to prices and, at the same time, downside risks to the economy," he said during recent IMF meetings.

Carry trade, crypto implications

Japan's policy moves carry outsized influence on global liquidity and risk appetite, including crypto. The yen carry trade – borrowing cheaply in yen to invest in higher-yielding assets worldwide, including cryptocurrencies – amplifies market sentiment. A stronger yen or higher rates can trigger rapid unwinds.

Past episodes of yen strength have coincided with tighter funding conditions, reduced risk-taking, and pullbacks in Bitcoin (BTC) alongside equities, as seen during the August 2024 volatility when a modest BoJ tightening contributed to sharp crypto declines. With the BoJ widely expected to hold in April but keep the door open for June, any shift will shape the broader macro backdrop for digital assets.