Bank of Japan Governor (BOJ) Kazuo Ueda said on Monday that uncertainty over the conflict in the Middle East was leaving markets unstable, warning that it could also hurt factory output, thus signalling the bank's escalating alarm over the economic hit from the protracted war.
Ueda also stressed the need for vigilance against fallout from the Iran war in explaining the outlook for monetary policy, rather than sticking to the BOJ's script pledging to keep raising interest rates.
"Global financial markets are unstable, and crude oil prices are rising sharply due to Middle East tensions. We must be vigilant to future developments," Ueda was quoted as saying in a speech read by his deputy, Ryozo Himino.
"Given lingering uncertainty over the Middle East situation, we will scrutinize how future developments affect the economy, prices and financial conditions, as well as risks and likelihood of our baseline projections materializing."
Markets watched his speech closely for hints on whether the BOJ would raise interest rates this month, chances of which have receded as fading hopes for an end to the Iran war keep markets volatile and muddy the economic outlook, sources told Reuters.
The reference to the uncertainty is a shift from March's guidance, when the BOJ said only that it would keep raising rates in line with improvements in the economy and prices.
In his speech, Ueda said a gradual economic recovery was keeping underlying inflation on track to hit the BOJ's target of 2%, with companies offering solid pay increases in this year's wage talks.
But he warned that rising crude oil prices would hurt Japan's economy, as a protracted Middle East war could weigh on factory output amid supply chain disruptions.
Ueda's focus on downside economic risks suggests the BOJ is becoming less convinced that its growth and price projections will materialize, said Mari Iwashita, executive rates strategist at Nomura Securities.
Delaying rate hikes is not without cost, as that could cause unwelcome yen falls, push up import costs and broader inflation, analysts say.
Japan's benchmark bond yield jumped to a 29-year high on Monday, fuelled partly by investors' concern that surging oil costs would add to mounting inflationary pressures.
While higher oil costs would push up energy prices in the short-term, they could exert both upward and downward pressures on underlying inflation, Ueda said.
"If the output gap worsens, that could weigh on underlying inflation," he added.
"On the other hand, if rising crude oil prices heighten the public's medium- and long-term inflation expectations, that could push up underlying inflation."
