Bank of Japan (BOJ) Deputy Governor Ryozo Himino warned that U.S. trade policy remains a major source of uncertainty for Japan’s economy, even as the central bank continues to plan further interest rate hikes amid stubborn inflation.

In a speech delivered to business leaders in Eastern Hokkaido, Himino—a key architect of Japan’s monetary normalization—stressed that the BOJ will proceed cautiously, balancing the need to support the economy with the goal of achieving sustained 2% inflation.

Key Risks: U.S. Tariffs and Policy Uncertainty

Himino identified the new U.S. administration’s trade and foreign policy as a critical variable for Japan’s economic outlook. He described its approach as “holistic,” blending economic, security, and political goals in ways that often defy conventional economic models.

“The administration is highly flexible tactically but persistent strategically,” he said. “This makes forecasting difficult.”

He outlined four key channels through which U.S. policy could affect Japan:

1. Direct trade effects: Japanese exporters may have to choose between absorbing tariffs or losing market share.

2. Uncertainty effects: Frequent changes in tariff rates disrupt supply chain and investment planning.

3. Global slowdown: Weaker U.S. or global growth could reduce demand for Japanese exports.

4. Financial market volatility: Shifts in risk sentiment could tighten financial conditions.

Despite these risks, Japan’s exports and corporate investment have so far remained resilient. But Himino cautioned that the full impact may yet materialize.

Inflation: Underlying Trend Still Below Target

Headline inflation reached 3.1% in July, but Himino emphasized that this was largely driven by temporary factors—especially rising rice prices and spillovers to other food items.

The underlying inflation rate—which excludes volatile food and energy prices—stood at 1.6%, still below the BOJ’s 2% target.

“We are seeing progress, but we are not yet at a point where inflation is sustainably at 2%,” he said.

He noted that labor shortages and changing corporate pricing behavior could be contributing to more persistent price pressures, but also highlighted that downside risks—including a global slowdown—could reverse recent gains.

Monetary Policy: Gradual Hikes and Balanced Sheet Reduction

Himino reaffirmed that the BOJ intends to continue raising interest rates gradually, given that real interest rates remain deeply negative.

He also detailed the bank’s plan to reduce its bond purchases—from around ¥6 trillion per month to roughly ¥3 trillion by early 2026, and eventually to ¥2 trillion by 2027.

The reduction is designed to be predictable but flexible, allowing the BOJ to intervene if long-term interest rates rise too rapidly.

Five considerations guide the BOJ’s balance sheet strategy:

1. Limited evidence that reserve reduction directly affects inflation under current conditions.

2. Short-term interest rates remain the primary monetary tool.

3. Excessive BOJ bond ownership harms market functioning.

4. Banks still need adequate reserves for liquidity.

5. A smaller balance sheet reduces financial risk for the BOJ itself.

Implications for International Business and Investors

• Exporters and manufacturers with exposure to the U.S. should model multiple tariff scenarios and build contingency plans.

• Investors should expect further JPY strength over time as interest rates rise, but volatility may persist due to external uncertainties.

• Corporate strategists should note that Japan’ underlying inflation trend is still evolving—wage and price dynamics bear close watching.

• Financial institutions operating in Japan should prepare for continued, but gradual, monetary normalization.

Himino’s speech underscores that Japan’s policy path remains data-dependent and calibrated to avoid disruption. For now, the BOJ is walking a narrow road—raising rates just fast enough to keep pace with inflation, but not so fast that it endangers economic stability.