Ueda underscores significance of anchoring inflation near 2% as AI and energy lift prices

The yen's modest increase indicated that markets interpreted the comments as confirming the BoJ's current hawkish stance, not as a hint of a hike in October. Oil serves as a crucial transmission mechanism for Japan: being a large energy importer, it directly experiences Middle East price hikes, and higher oil prices both increase inflation and worsen the trade deficit. That creates opposing effects for the yen. By portraying AI demand and labour market conditions as genuine demand-side pressures, Ueda strengthens the position of hawks, potentially supporting short-term Japanese government bond yields. The October meeting's review of underlying inflation now acts as the primary trigger for the yen.

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Ueda is subtly arguing that Japan's inflation is not solely due to imported energy, and that change will ultimately provide justification for the BoJ's next rate increase.

Summary of Ueda's comments:

• It is growing more critical to pin underlying inflation near 2%, stated BoJ Governor Kazuo Ueda.
• Japan is undergoing a beneficial cycle of wage growth and price recovery, he noted.
• Supply-side price rises were chalked up to Middle East energy expenses, while demand-side increases were attributed to robust AI demand worldwide, funding capital outlays, exports and product prices.
• The modest economic rebound and a taut labour market are also pushing up inflation.
• The yen climbed slightly after the remarks.
• The BoJ's policy rate stands at 1.25%, with the next decision scheduled for October 30.

According to Kazuo Ueda, BoJ chief, grounding underlying inflation near the Bank's 2% objective is gaining significance, outlining a situation where both supply disruptions and robust demand are propelling prices upward in Japan.

In comments that were reported early Monday in Asia, Ueda indicated Japan is experiencing a positive cycle of rising wages and price recovery. He then broke down the price pressures into two categories. For the supply side, the Middle East conflict is raising energy costs and many other goods. On the demand side, exceptionally strong global demand for AI is stimulating domestic investment, exports, and the prices of various items.

He also noted that Japan's moderate economic upturn and a constrained labour market are contributing to inflation.

The difference is important for policy formulation. Central banks normally disregard supply-driven inflation, like a spike in energy prices, because it is expected to subside. In contrast, demand-driven inflation is the variety that monetary policy is built to handle. By emphasizing AI-related demand and a tight jobs market together with the energy shock, Ueda seems to be constructing a case that the recent price increases are not simply short-term.

These statements extend from remarks made late last week, when Ueda stated that the BoJ would keep hiking interest rates as underlying inflation nears 2%, and that the timing and speed of increases would be determined by exchange rates, AI-driven demand, and Middle East developments. He also stated that officials at the next meeting would discuss potentially changing their assessment of underlying inflation.

The BoJ's short-term policy rate is currently 1.25%, and the next rate decision is set for October 30. Market indicators have suggested a move is unlikely at that meeting, but the language about anchoring inflation maintains the possibility of a rate rise in the near term.

The yen gained a little ground after the statements.

The primary question for markets is whether the BoJ will formally revise its view of underlying inflation at the October meeting. Such a change would indicate that the prerequisites for the next rate increase are aligning, even if the bank opts to hold off.