Bank of Japan Navigates Inflation Risks Amidst Middle East Tensions

TOKYO, JAPAN – February 5, 2026 – The Bank of Japan (BOJ) is carefully monitoring the potential for escalating inflation, particularly in light of rising geopolitical tensions in the Middle East. Having ended the world’s only negative interest rate regime in 2024, the BOJ is focused on achieving sustained levels of inflation, but faces a complex economic landscape.

Inflationary Pressures and the BOJ’s Dilemma

Headline inflation in Japan has remained above the BOJ’s 2% target for 45 consecutive months, though it experienced a slight cooling in January 2026. The ongoing conflict in the Middle East presents a renewed risk of fueling inflation, a concern explicitly acknowledged by the BOJ when it maintained its current interest rate policy on Thursday.

For Japan, which imports nearly all of its oil, the current inflationary environment represents a “cost-push” scenario – an increase in prices driven by external factors rather than increased domestic spending – as opposed to the “demand-pull” inflation the BOJ has been aiming to stimulate.

Iran’s threats to escalate tensions and drive oil prices to $200 per barrel further exacerbate these concerns. This comes at a time when Japan has experienced a prolonged period of wage stagnation, with real wages declining throughout 2025 before a modest gain of 1.4% in January.

The Importance of Wage Growth

The BOJ has been seeking inflation driven by wage growth, creating a virtuous cycle of rising prices and incomes. Prime Minister Sanae Takaichi has reportedly emphasized the importance of achieving the inflation target through wage increases, rather than rising raw material costs.

Thomas Rupf, chief investment officer for Asia at VP Bank, anticipates a noticeable increase in inflation starting in March. He explained to CNBC that “Higher global energy prices following the conflict, combined with Japan’s heavy reliance on imported energy and a weaker yen, will likely pass through quickly to consumer prices.” Rupf suggests inflation could rebound beyond the 2% mark.

Energy Prices and Their Impact

BOJ Governor Ueda has also acknowledged the accelerating underlying inflation in Japan, reiterating the need for wage gains to accompany price increases. He previously warned Japan’s parliament that rising crude oil prices would negatively impact the country’s terms of trade and economy, potentially pushing up underlying inflation if sustained.

Sam Jochim, an economist at Swiss private bank EFG, estimates that a 10% increase in energy prices could directly translate to a 0.7% rise in Japan’s overall inflation, given energy’s 7% weighting in the Consumer Price Index (CPI) basket. But, Jochim notes that the overall impact could be larger, as energy is a crucial input in the production of many goods and services.

Hirofumi Suzuki, chief FX strategist and head of research at Sumitomo Mitsui Banking Corporation, shares this view, stating that for every 20% increase in oil prices, Japan’s CPI could increase by 0.3%. He notes a pre-conflict baseline oil price of $60 per barrel and suggests the situation is increasing the risk of stronger upward pressure on overall prices.

Mitigating Factors and Policy Challenges

Despite these concerns, Japan holds significant oil reserves, equivalent to 254 days of domestic consumption as of February, providing some buffer against price shocks.

The “cost-push” scenario presents a policy bind for the BOJ, forcing a deliberation between raising interest rates to curb inflation or maintaining them to support growth in the world’s fourth-largest economy. VP Bank’s Rupf suggests that if inflation rises alongside supportive fiscal policy, the BOJ may need to accelerate its policy normalization.

EFG’s Jochim points out that inflation caused by external energy price increases represents a supply shock that would likely hinder economic growth, creating a difficult trade-off for the BOJ. Analysts suggest that raising rates would be ineffective against “cost-push” inflation, which targets demand. A “wait-and-see” approach is considered more realistic than rushing to raise rates.