By Leika Kihara

TOKYO (Reuters)

The Bank of Japan (BOJ) is increasingly cautious about raising interest rates, relying heavily on a less conventional inflation measure. While consumer inflation is at multi-year highs, underlying inflation remains below the BOJ’s 2% target.

Analysts suggest that the BOJ’s concerns about local consumption and the global economy complicate its ability to manage inflation expectations, especially after years of deflation.

Former BOJ official Nobuyasu Atago, now chief economist at Rakuten Securities, notes that the central bank’s use of the ambiguous term “underlying inflation” complicates communication regarding their policy intentions.

BOJ Governor Kazuo Ueda acknowledged the difficulty of resetting inflation expectations while maintaining an accommodative stance, highlighting that they’ve moved expectations from zero but struggle to anchor them at 2%.

Japan’s headline inflation hit 3.6% in April, significantly above the U.S.’s 2.3%, but core measures—excluding volatile food and fuel—have also trended above the target. However, the BOJ’s preferred underlying inflation measures are still below 2%.

These metrics reflect concerns regarding the economic impact of rising U.S. tariffs and explain the pause in interest rate hikes after January’s increment to 0.5%. A source close to the BOJ noted that households are more affected by food prices than abstract concepts like underlying inflation.

The BOJ anticipates that its inflation gap may close if food prices stabilize and wage growth supports consumption. Economists predict the next rate increase might occur in early 2026. However, communication about the bank’s cautious position poses challenges, especially amid ongoing economic uncertainties.

Internal divisions within the BOJ are surfacing, with board member Naoki Tamura advocating for attention to inflation expectations from businesses and consumers, arguing that if inflation risks rise, decisive action may be necessary to ensure price stability.